After a steep interest rate hike last year, the US Fed has remarkably slowed down in 2023. Thanks to the easing inflation, the rate hike pace will likely remain much slower this year. And one of the beneficiaries of this changing macro stance is utilities.
Utilities and interest rates generally trade inversely to each other. As the former is considered a “bond-proxy,” they might gain sheen compared to bonds when rates pause or start declining. TSX utility stocks have already started seeing investor enthusiasm in the last few weeks. Canadian Utilities (TSX:CU) has gained 12% since last month, notably beating broader markets.
Earnings and dividend stability
What stands tall for Canadian Utilities is its slow-but-stable earnings growth. Its regulated operations provide a solid footing for recurring cash flows, regardless of the macroeconomic challenges. In the last decade, net income has grown by 2% compounded annually. That’s much lower than the broader market average. However, its earnings visibility and low-risk business profile facilitate stability.
Thanks to such slow and consistent growth, Canadian Utilities has grown its shareholder payouts for the last 51 consecutive years. That’s a remarkable feat and highlights dividend reliability. The stock yields a decent 4.5%, higher than the TSX utility average. In comparison, one of Canada’s favourite utility stocks, Fortis (TSX:FTS), yields 3.8%. It also has exposure to large regulated operations that enable stable financial and dividend growth.
Superior payout ratio
Utilities generally have high payout ratios as they distribute a big chunk of their earnings to shareholders. For example, CU gave away 85% of its earnings on average annually in the last decade. And note that such high payout ratios are not rare among utilities. The industry-average payout ratio is close to 70%, while broader markets generally give away 15%–20% of their earnings as dividends.
Low correlation and recession-resilience
Another advantage utility stocks like CU possess is their low correlation with stocks at large. As markets turn rough, investors take shelter with slow-moving, dividend-paying utility stocks. We saw this during the pandemic crash. In March 2020, broad market indexes declined by 30%, while utility stocks corrected by only 10%. They were also quick to recover and even kept dividends growing.
A favourable risk-reward proposition differentiates them among peers. The demand for utility services does not change significantly in an economic boom or bust. So, their earnings and dividends largely remain in line during recessions and even in economic expansions. Canadian Utilities has seen several recessions in the past and only kept growing its shareholder payouts. That indicates the management’s confidence in its future earnings growth and sturdy financial position.
As the odds of a recession have increased this year, TSX utilities have been on the rise. Stocks like CU with stable dividends will likely remain in the limelight this year given the uncertainty in equities.
Investor takeaway
If you are a growth investor, CU might disappoint with its mediocre returns. But when the objective is stability over growth, CU is one of the best picks. This utility stock has returned 4% and 10% compounded annually in the last decade and two decades, respectively.
