Why Fortis Inc. Is the Ideal Hedge Against Economic Uncertainty

Growing market volatility and further concerns over the state of the global economy are forcing investors to focus on defensive stocks and companies with strong fundamentals when investing.

One of the best sectors for investors to consider as a means of protecting their portfolio against this economic uncertainty and market volatility is the utilities sector. This is because of the inelastic demand for the services and products provided by utilities, coupled with steep barriers to entry, which protect their competitive advantage.

My preferred Canadian utility investment is electricity provider Fortis Inc. (TSX: FTS). The company possesses a solid underlying business, strong growth prospects, low earnings volatility, and a solid balance sheet. It is these characteristics that give Fortis the ability to reward investors through a regular and steadily appreciating dividend payment.

As you can see, Fortis has hiked its dividend payment almost every year since inception in 1972.

Fortis Dividend History 291014

Source: Fortis Inc.

As a result of these regular dividend hikes, Fortis now pays a dividend with a juicy yield of 3.5% coupled with a sustainable payout ratio of 84%. While the payout ratio may appear a little high to be comfortable, it is calculated using net income and I believe this does not accurately reflect the company’s true ability to sustain the dividend payment.

This because net income includes a number of non-cash items that distort Fortis’ true cash position. I believe operating cash flow offers a far more accurate representation of a company’s ability to meet its liabilities, particularly in a capital-intensive industry like electric utilities. When Fortis’ operating cash flow is substituted for net income, the payout ratio falls to a conservative 22%, indicating the dividend is certainly sustainable.

More impressively, since inception Fortis’ dividend has grown at a compound annual growth rate of 5.6%, well above the annual rate of inflation for that period. This ensures the real rate of return available to investors from Fortis’ dividend payments is not eroded.

As an electric utility, Fortis possesses a wide, multifaceted economic moat that protects its competitive advantage and gives it a degree of pricing control, which helps to reduce earnings volatility.

Perhaps even more significantly, with electricity as a modern necessity its demand is inelastic, shielding Fortis earnings during sustained economic downturns and almost guaranteeing earnings growth when the economy is strong. This further reduces Fortis earnings volatility and bodes well for further dividend hikes.

I believe all of these characteristics make Fortis a solid defensive addition to any share portfolio. With it set to reduce investment volatility while enhancing dividend stability, making it a superb hedge against the current market volatility and economic uncertainty.

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Fool contributor Matt Smith has no position in any stocks mentioned.

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