If I were to ask a knowledgeable dividend growth investor a list of their favourite Canadian stocks, I’m fairly sure Fortis Inc. (TSX:FTS) would be high on the list. Heck, it might even top the list.
Fortis is essentially responsible growth personified in a company. It started with humble roots in Newfoundland as a power generator before expanding across the country. Now, it has power assets in Atlantic Canada, Ontario, British Columbia, as well as in the U.S. and the Caribbean. It also has natural gas assets in many of the same markets, as well as a collection of 23 different hotels across eight different provinces, and 2.8 million square feet of retail and commercial space in Atlantic Canada.
In short, the company has come a long way since its humble beginnings on The Rock.
Perhaps the biggest reason to like Fortis is the company’s unparalleled record of dividend growth, at least measured to its peers in Canada. Fortis has raised its dividend each year since 1972, and has already committed to an increase in 2015, from $0.32 per share per quarter to $0.34. That history of growth, plus a current 3.5% yield, make Fortis an attractive investment for dividend growth investors.
But one thing we all have to remember is there’s more to consider than just a company’s history. Looking towards the future is a lot more difficult than looking backwards, but it’s an important part of investing. When I look towards the future, I don’t see how the next few years can be as good for Fortis as the last few were.
Like a lot of big, conservatively managed utilities, Fortis is only likely to grow as fast as inflation until it makes another acquisition.
The company is projected to earn $2.09 in 2015 and then $2.13 in 2016. That’s a pretty pedestrian growth rate of less than 2%. And yet, the stock trades at 18.5 times its projected 2015 earnings.
Looking at it from a free cash flow perspective, the outlook actually gets worse. The company did generate $982 million from operations in 2014—good enough for a return of about 5% of its enterprise value—but actually had negative free cash flow once you add on its $1.7 billion in capital expenditures. In fact, the company hasn’t generated positive free cash flow in its last four fiscal years. It’s good that it’s investing in the business, but that means that it actually has to borrow each year to keep growing the dividend.
The debt is also somewhat worrisome. At the end of 2011, the company had $6.4 billion in total debt. As of the end of 2014, it has nearly doubled its total indebtedness to $11.5 billion. Even though it borrowed more than $5 billion over the last few years, the company’s cash flow barely budged, going up from $911 million to $982 million. And that’s not even counting the company’s preferred shares, which also went up substantially in that time.
To put it another way, Fortis has borrowed $5.1 billion and has only increased cash flow by $70 million. That’s not a good return on that borrowed money.
Should you sell?
I’m not ready to throw in the towel on Fortis just yet, which is why I’m recommending that investors be cautious with this stock.
Everyone’s personal situation is different. If you’ve held Fortis for years, you’re likely looking at some big capital gains, and nobody wants to deal with those. Considering how the dividend can be expected to keep chugging upwards, investors may be prudent to just hold on to the shares, rather than dumping them.
Buying high-quality companies is important, but it’s also important to buy them at reasonable prices. Fortis remains a great stock; it’s just a little too expensive.
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Fool contributor Nelson Smith has no position in any stocks mentioned.