Fortis Stock: The Sub-Par Performance Continues Due To Valuation (NYSE:FTS)

Please note that all amounts are in CAD with the exception where it’s otherwise noted.

Dear readers/followers,

Since my last article on Fortis (NYSE:FTS), which by the way you can find here the stock hasn’t exactly outperformed. This update is for my latest article, which at this point is almost half a year old, and which has seen the company substantially underperform most major indices. This is because of a slight dividend-inclusive negative RoR.

So, this company hasn’t done that well, nor is likely to give massive market-outperforming RoR in the future. Fortis is far too stable a business – 40-50% RoR is possible over the longer term, but I highly doubt we’ll see some sort of “spike” for a utility business yielding 4.4%, even if that utility is A-rated.

It’s a tricky market, and I do invest plenty of capital in utilities – in businesses like Enel (OTCPK:ENLAY), UGI (UGI), Evergy (EVRG), Black Hills (BKH) and others. I do not maintain a relevant position in Fortis at this time, nor do I as of this article have any intention of starting one, beyond the very few shares I hold. When it comes to utilities in Canada, my choice remains Enbridge (ENB), which I by the way still believe can be a solid “BUY” at this time.

Fortis – A 6-month update going into 2024E

Still, this company does deserve a 2024E update. One of the strongest arguments for investing in this stock is in fact that it is so stable. The company may not be an impressive grower by any sort of metric with only 2-3% per year and no forecast or outlook for this increasing, but it’s one of the most stable utilities on the entire planet. There is something said for “buying below X, sell above Y” for this stock.

The company’s electrical and gas utilities across all of NA, with the crown jewel in the form of ITC Holding, give the company a very clear pathway of U.S transmission upside due to the overall aging infrastructure, which supports the potential growth from renewable energy sources. From what I have been able to garner from the documentation with the regulators, dialogues, and discussions here are more than positive, with ITC managing RoE’s at a significantly higher rate than state-allowed returns and beyond the typical upsides for regulatory lag.

The company has many appealing operations – but ITC is a core here, positioned to secure plenty of additional transmission investments in the coming years. One of the company’s other appealing assets set for growth is UNS Energy, which is likely to see better growth than many of its national peers due to better migratory/demographic trends with population growth and a clear transition to a more regulatory-friendly generation (if you read the AZ rate case where RoE of 9.75% was allowed, you’ll see the logic here).

There are some assets I would view as more “troubled” – anything on the coasts, where CH Energy, a NY-based asset is working, is something I would view with a more conservative eye given both the trends and the regulatory environments in many of the eastern and western coasts in the US.

For the Canadian part of the company, I would generally view these as very low risk overall. Returns are lower here, yes – but that’s due to lower equity components/lower costs of capital compared to the US.

Like any utility at this stage, Fortis is about the execution of its investment projects – which the company hopes will support a mid-single-digit rate growth per annum over the next few years, with a focus on the two aforementioned utilities combined with the Fortis BC (British Columbia) part of the company.

As you can see, this company is in no way a poor operation. I also want to make clear and say that I do not see Fortis as a “bad” investment – I only say that I see better opportunities on the market today. Especially after the drop, which we’ll go into in the next two sections of the article, the company is obviously more appealing here. The stability of its forecast is another argument clearly in its favor – and no wonder the company is this stable.

The company is well ahead on its pathway to reducing emissions, with 33% GHG emission reduction achieved since 2019, and a net-zero target by 2050 at the latest. The rate cases I discussed from IRP support the company’s coal exits, with a complete coal-freeness by 2032, replaced by renewables, energy storage, and hydrogen/natgas.

The company’s currently planned capital plan until 2028E includes a rate base increase to close to $50B, with a capital plan primarily focused on smaller projects (80% of them) rather than larger ones, with investments into transmission infrastructure, clean energy, and other solutions.

MISO is a very good example of this.

Together with the company’s investment-grade credit ratings, this means that there is overall very little worry for this company. With an A-/A-low rating from the major agencies, the company is among the better-rated utilities on the planet. Even with the ongoing rate cases in BC, Alberta, and Central Hudson outlook, with ITC ongoing, the company is set to improve.

Dividend fundamentals are also very stable. The company’s earnings are growing, and the company’s dividend payout ratio has never gone above 80% – it’s in fact lower today on an adjusted basis than it was back in 2020, and is now at 74%. The increases come in at the low-to-mid range single-digit level, with guidance towards this sort of growth until at least 2028.

This also means that the company has, as of the last 20-year TSR, outperformed the broader indices.

The lag over the last few years becomes clear when you look at the trends above. I believe, for a certainty, that Fortis is becoming more attractive as it drops.

Its premium is deflating – at current levels, it’s far from “undervalued”, but it’s definitely approaching a point where I can see myself buying more. The main hindrance at this time is the simple fact that there are many other companies with superb upsides in this sector – some of which I mentioned earlier.

Let’s look at some of the risks and upsides to this company and investment.

Fortis – an Upside for this investment, as well as some risks

Aside from valuation, which we’ll get into in a bit, we’ll look at a few risks worth considering prior to your investment. Now, some analysts point to the company’s growth craze as opening the door to overpaying for acquisitions in the US space. However, this isn’t as much of a risk anymore, I’d say – because management has been clear about its target for organic, internal growth rather than further inorganic growth.

As with all of these types of companies, high interest rates are a bit of a net negative for both the valuation and operation of these companies. Their yields of make them unattractive investments when the risk-free rate is above 4%, and at the same time, interest rate increases push refinancing costs up – which acts as a double-unattractive point, as this limits and constrains dividend potential. In short, it’s completely natural that Fortis has been on a declining trend for the past 1-2 years, and I don’t see that changing massively until we get a new interest rate situation.

On the plus side, we have very stable business operations, and I see the company’s 6% earnings growth target as likely, which will keep the dividend competitive even if it’s below inflation. The company is also a business that has kept this dividend steady and rising for a long time and has paid dividends for over 40 years and counting.

As such, I would view the risk/reward profile as favorable – provided the valuation is “correct”.

Fortis – Difficult to premiumize here, but it’s getting attractive.

There’s no doubt that this company is more attractive now than it was when I previously wrote about it. However, at 17x+ P/E, it’s far from “cheap”. Then again, Fortis is almost never at a price or valuation that could be considered “cheap” by normal metrics. Even during the GFC, it only fell below 15x during a short time.

Therefore, we need to really consider where Fortis should be bought – and I would argue here that the time is in fact fairly close.

Very, very few companies show this sort of “boring stability”. Even most utilities are far more volatile than this. It’s also fair to say that this company has been trading relatively “flat” for over 2 years, but that this trend, given where interest rates were (and you can see the valuation for that period) and where they are going (likely down), we’ll see some reversal at some point – the question is how long things would go here.

In my previous article I made a case for buying Fortis at $50, and to tell you the truth, I expected the company to drop more than it has here. It’s a testament to the quality of the business.

With a 10-20% MoE, the company always hits its earnings targets, 100% of the time.

The fact is, I wish I could say that the company is a “BUY” here, but the simple fact is that the math does not support it. Even at a premiumized 19.5x P/E, the company’s upside is less than 13% annually at this time. The very least I would want is that upside being 15% before going in, and this calls for a share price of at most $52/share for the Canadian ticker. Above that, the thesis doesn’t work for me – and because the company is so accurate, I see neither up nor downside risks at a significant degree in any scenario. What would change this would be if we were looking at further rate increases in the eye – but this seems like a very unlikely prospect at this time.

As such, I would at this time raise my PT for Fortis to $52/share for the Canadian ticker, but would maintain my rating of “HOLD” at this time until such time that the company drops.

Until then, I would buy other utilities with more attractive valuations.

Thesis

My thesis for Fortis is:

• An absolutely solid, A-grade utility with safety that can’t be beaten by really any business on the NA market in the same sector. A definite “BUY” at the right valuation, with an excellent potential yield.
• However, 18-22X P/E is the historical high. The P/E to “BUY” FTS is no higher than 18-19X and preferably lower than 17X P/E. That’s when you stand to gain that double-digit RoR that we so want to have.
• FTS is still a “HOLD” here, but one that’s moving very close to a fair-value “BUY”. I would set that price at around $52/share.

Remember, I’m all about :

1. Buying undervalued – even if that undervaluation is slight, and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn’t go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized)

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

There’s only an upside here if you give the company a premium – and in this market environment, I am unwilling to legitimize this premium, even with this company’s overall appeal in terms of quality.