Fortis (TSX:FTS) recently gave back some of the big gains it racked up in the second half of 2024. Investors who missed the rally last year are wondering if FTS stock is now undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio focused on dividends and total returns.
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Fortis share price
Fortis trades near $58.50 at the time of writing. The stock is down about 8% from the 12-month high but is still up more than 8% over the past six months.
Interest rate changes in Canada and the United States have largely driven the movements in the share price over the past two years.
In 2022 and 2023, the Bank of Canada and the U.S. Federal Reserve raised interest rates aggressively to get inflation under control. Higher interest rates lead to more expensive borrowing costs. Fortis and other utilities grow through investments in large capital projects that can cost billions of dollars and sometimes take years to complete. Debt is used to fund the projects until they are completed.
A jump in debt expenses cuts into profits and can reduce the cash that is available for distributions to shareholders or for debt reduction. Higher borrowing costs can also force a company to put some projects on hold, potentially limiting growth.
The rally in Fortis that occurred in the second half of 2024 coincided with rate cuts in Canada and the United States. Falling rates tend to be good for utility stocks.
Risks
Strong jobs data, sticky inflation, and uncertainty around tariffs in the United States could force the U.S. Federal Reserve to put rate cuts on hold in 2025. Some analysts think the American central bank might even raise rates again before the end of 2025 or in 2026.
In Canada, the argument for more rate cuts is stronger, but the Bank of Canada would likely slow the pace of rate reductions if the American central bank stopped cutting rates. Surging bond yields in both countries in the past few weeks suggest the market expects fewer cuts than previously anticipated. This is the reason Fortis has pulled back over the past two months. More downside could be on the way.
Opportunity
Fortis is working on a $26 billion capital program that will raise the rate base from roughly $39 billion in 2024 to $53 billion in 2029. As the new assets go into service, the company expects cash flow to rise enough to support planned annual dividend increases of 4% to 6%.
Fortis has increased the distribution in each of the past 51 years, so investors should feel comfortable with the guidance. At the time of writing, the stock provides a dividend yield of 4.2%.
Fortis has other projects under consideration that could get added to the backlog. In addition, Fortis has a good track record of making strategic acquisitions.
Time to buy?
Near-term volatility should be expected as the market sorts out its expectations for interest rates over the next couple of years. That being said, income investors should be comfortable holding Fortis at this level and might look to add to the position on further downside. The dividend is attractive and should continue to grow.
