Utility stocks have been on a tear in 2019, which is hard for value investors, because we don’t like to pay at or above fair value for anything, let alone a stock. However, we sometimes get lucky because some external events that companies have no control over can sometimes overshadow all the good work a utility is doing, and scared investors tend to dump the stock and move on.
Something like that has recently happened to one of my favourite utility stocks, Emera (TSX: EMA), one of Canada’s largest and most diversified utilities with a predominately regulated portfolio of electric and natural gas operations. Emera started off the year at around $43 after getting hammered for the better part of 2018 and then steadily climbed to $58 by the end of September 2019.
There was a lot of investor interest in riding this wave, and a lot of people got into the stock in the $50s, only to be disappointed as the stock price stalled and then caught a bad “cold,” coming all the way down to $52 at time of writing. Most of the investor angst is a result of anticipated weakness as Hurricane Dorian devastated the Bahamas, where Emera has significant operations.
Lower quantity but higher-quality earnings
The company compounded its problems by coming out with stinky Q3 earnings last week. Most people who just read the surface-level headlines would say that earnings were very weak, but I disagree. My view is that while the headline earnings numbers were weak, the actual underlying base earnings from its regulated business went from being high quality to super high quality.
Sometimes, it is important to do a trade-off between quality and quantity of earnings. This is an important concept for smart investors to properly grasp. For example, two banks could have the same total earnings, but one could derive more of it from stable retail operations versus the other, which derives it from volatile capital markets operations.
The lower-risk retail operations in banking parlance can be directly translated to a utility’s regulated business. The regulated part of any utility business acts as the stable and secure foundation upon which the company can take calculated bets on higher growth, be it unregulated businesses or perhaps geographic growth.
Emera’s regulated portfolio is second to none in terms of quality, with 95% of its earnings coming from highly regulated sources, which guarantees the company and its investors a high degree of visibility to its year-over-year cash flow.
So, why do I believe that $10,000 invested in Emera will turn into $44,000 in a decade? Well, this bold prediction is not quite as bold when you consider that I have 20 years of returns data to rely on.
The company recorded an annual total shareholder return of almost 12% for the last two decades, which is unreal considering that equity markets are supposed to deliver about 6-7% over the long term. This means that Emera has comfortably beat the market for the last two decades. If that isn’t the very definition of consistent outperformance, I don’t know what is.
Now, naysayers might point to the fact that you have to look at recent history because the company has significantly grown its U.S. operations in the last decade, so a 10-year return profile is more relevant. It should come as no surprise to investors that the 10-year return profile is even better.
The company has clocked in a crazy 16% annual shareholder return over the last decade, which means its big bet in the Florida market represents an excellent use of shareholder capital.
So, if we take $10,000 from our TFSA and plunk it into Emera for the next decade, assuming the same 16% return, including its stable and growing dividend, we would end up with $44,000. Of course, this assumes that the dividends were reinvested into further shares of Emera, which super-charges the effect of time compounding.
Foolish bottom line
Emera has a fantastic long-term business at a very low-risk level and a highly visible future stream of cash flows. Smart investors will do very well to tune out short-term earnings noise and accumulate shares at around $50 to set up for an amazingly resilient and predictable TFSA portfolio in retirement.
