Last year, interest rate hikes amid higher inflation were a key theme in markets. Rising recession fears will likely be a crucial factor for them this year. Recently released Fed minutes indicate that the central bank expects a big drop in economic activity for the entire of 2023. Thus, after the banking crisis and policy tightening shocks, risky asset classes might again turn lower.
Defensives like utilities will likely be in the limelight in that case. Their stable dividend payments and less volatile stock can protect investor capital in uncertain times. Here’s why Canada’s top utility stock Fortis (TSX:FTS) looks well placed in the current environment.
Earnings stability in almost all economic cycles
Utility companies like Fortis keep growing steadily in nearly all economic cycles due to their stable demand. Plus, their large exposure to regulated operations makes the cash flow all the more stable. For example, Fortis has managed to grow its bottom line by 5% compounded annually in the last decade. Because of such financial stability and visibility, stocks like FTS witness much less volatility compared to growth stocks. This could be a big differentiating factor in the current times.
Stable dividends
Even if utilities see an earnings decline, their dividends hardly take a hit. Fortis has increased its shareholder payouts for the last 50 consecutive years. Interestingly, such a long dividend growth streak is quite common among utilities. We saw steep dividend cuts or even suspensions in many sectors during the pandemic. However, utilities like FTS kept their dividend growth run intact. FTS stock currently yields 4%.
Utilities can afford to give away a large portion of their earnings as dividends to shareholders. That’s why they have high payout ratios. Fortis distributed around 52% of its net income in the form of dividends last year. That’s much higher than the broad market average of around 20%.
Fortis intends to increase its dividends by 5% annually for the next few years. Such dividend growth visibility stands particularly tall in this uncertain environment.
Inverting interest rate hike cycle
Interest rates and utility stocks generally trade inversely to each other. As a result, FTS stock, along with its peers, underperformed amid rapid rate hikes last year. However, as the rate hike cycle is expected to pause this year, utility stocks will likely gain a sheen. Even if we might not see any rate cut, a pause will boost investor sentiment.
Moreover, if we do see a recession this year, market participants will take shelter in stable dividend-paying companies like FTS. So, it will again be a key positive trigger for these defensives.
Investor takeaway
FTS stock has returned 10% compounded annually in the last 5 and 10 years. That’s a decent return for a defensive and even beat broader markets. Fortis is particularly strong when it comes to earnings and dividend stability. You might see insignificant returns in the short term, but if your investment horizon is beyond five years, FTS is an apt bet.
