While recession fears are rising, investors will increasingly move toward defensives. Thus, TSX utility stocks will remain in the limelight, particularly driven by the hopes of slowing rate hikes. But if you want to choose between Algonquin Power (TSX: AQN) and Fortis (TSX: FTS), which one would be a better bet?
Let’s see.
So far this year, Algonquin Power stock has soared a decent 30%, while Fortis has gained 12%. However, in the last 12 months, AQN stock has lost 42%, and FTS has lost 2%.
So, when it comes to defensive investing, what matters the most is earnings stability. Steady earnings growth facilitates stable dividend growth and less-volatile stock movements.
What’s so special about Fortis stock?
Fortis stands significantly tall in this aspect. Its large, rate-regulated operations drive stable cash flows in almost all economic cycles. And that’s why it has emerged strongly through numerous recessions and rate hike cycles over the decades.
Its per-share earnings have grown by 5%, compounded annually in the last decade. Although that looks too slow and dull, it enables safety. As a result, FTS has raised its shareholder payouts for the last 50 consecutive years. Through the pandemic, and even during the financial meltdown in 2008, the utility company kept its dividend-growth streak intact. FTS stock currently yields 3.8%.
What’s the deal with Algonquin?
In case of Algonquin, it also generates a large chunk of its revenues from regulated operations. To be precise, almost 88% of its total revenues come from regulated operations, while the rest comes from renewables. A significant part of its renewables output is sold via long-term contracts, which likely brings some sort of earnings volatility.
Note that its per-share earnings grew by a handsome 17% compounded annually in the last decade, thanks to its fast-paced renewables segment. However, as interest rates rapidly rose last year, its variable-rate debt turned poisonous and weighed on its bottom line.
Algonquin spent $279 million on interest expenses in 2022 — an increase from $210 million in 2021 and $182 million in 2020.
Considering the burden of higher interest expenses, it lowered the earnings guidance and cut dividends by 40% for 2023. That’s a steep cut for conservative, income-seeking investors.
Which one is better?
Fortis looks strong compared to Algonquin when it comes to earnings stability and dividend reliability. While last year’s glitches weighed on Algonquin’s finances, the troubles might not be all over this year. Its significant debt burden is quite concerning in this rising rate environment. AQN’s leverage ratio comes in around eight compared to FTS’s six. The leverage is on the higher side for both of them. However, with greater earnings visibility for FTS, it is a relatively less risky proposition.
Although the interest rate-hike cycle has slowed down this year, we might see a couple more hikes in the next few months. Plus, the recent boost in oil prices has complicated the entire situation. So, if the rate-hike cycle lasts longer than expected, that could be a negative for AQN.
Conclusion
When you are investing in utilities, stability is of utmost importance. Algonquin’s abnormally volatile stock and a steep dividend cut are rare among quality utilities. At the same time, such high turbulence is very rare in the case of Fortis. Even if it falls short on the growth front, you can sleep peacefully with it in your portfolio.
