The Bank of Canada maintained its key rate decision at 5% on Wednesday for the fifth consecutive time. Interest rate stability is good news for TSX utilities, which have significantly underperformed broad market benchmarks as interest rates, and therefore borrowing costs, have soared. However, utilities’ predictable and consistent earnings and cash flow earn them a place among the best stocks to buy right now as interest rates stabilize.
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Who should consider buying Canadian utility stocks?
Investors looking to add a reliable layer of passive income, portfolio defensiveness, and stable long-term growth potential to their retirement investment portfolios should check out TSX utilities as interest rates stabilize in March 2024.
Why now? Although borrowing costs remain at 22-year highs, the era of rising interest expenses that has dragged down utilities stocks seems to have passed. TSX utilities have calibrated their operating profiles and dividend programs to the higher rate environment. And given the stability in discount rates, industry stocks may rise higher when interest rates finally start to decline.
Fortis (TSX: FTS) and AltaGas (TSX: ALA) stocks look appealing today. Let’s see why.
Fortis stock
Fortis is a $25.7 billion electric and gas utility serving North America, with some assets in the Caribbean. Income-oriented investors will appreciate the high visibility of its dividend returns through 2028 and its potential for steady capital gains as it executes a record $25 billion capital investment plan, which is largely self-funded by internally generated cash flow.
Since 1990, Fortis’s stock has historically delivered 11.6% in annualized shareholder returns, which has ranked in the top quartile of its peer group and has beat benchmark indices. (Past performance may not indicate future returns, of course.) However, the company’s current investment plan targets growing revenue at a 6% annual rate. Regulatory developments on the utility’s rates have been supportive lately, and Fortis delivered adjusted earnings per share growth of 9% in 2023. Higher revenue and better earnings margins could drive FTS stock higher over the next five years.
Most noteworthy, the TSX utility stock marked 50 years of consecutive dividend growth following a 4.4% dividend raise in 2023. It’s a Canadian dividend king with an impressive track record. The current FTS stock quarterly dividend of $0.59 per share should yield 4.5% annually.
Management targets annual dividend increases in the 4% to 6% range as expenditure plans roll out through 2028. An investor who buys Fortis stock at current prices around under $53 a share could potentially earn a 5.7% dividend for 2029.
1 notable risk to closely watch on FTS stock
Fortis investors should watch the outcome of management’s engagements with credit rating agency S&P Global. The agency recently changed its rating outlook on FTS debt to negative, citing rising climate change risks, including wildfires. Fortis claims to have established a track record in successfully managing climate risks, and these never had a significant impact on its financial results.
Credit rating downgrades increase financing costs.
Regardless, FTS’s “A” category investment-grade rating from the S&P is still two notches above speculative grade. A downgrade will still land the utility within the investment-grade rating, mitigating negative impacts.
AltaGas stock
AltaGas is an $8.6 billion growth-oriented utility play that pays investors quarterly dividends yielding 4.1% annually. The TSX utility stock serves natural gas needs for customers in the United States and Canada. About 55% of its business is from utility assets, and the remainder is from midstream assets, including gas processing, transportation, and export to global clients.
Faced with growing demand for natural gas from utility customers (a strong revenue and earnings growth tailwind), AltaGas is using an equity self-funded growth model that’s minimizing leverage risks.
The utility stock pays 50% to 60% of its normalized earnings as dividends to ALA stock investors. The payout is well covered by recurring cash flow.
Looking ahead, utility modernization programs, customer growth, and a visibly low-risk growth profile should drive AltaGas stock higher. The TSX utility stock delivered 15.4% in annualized total returns over the past five years, yet it remains fairly valued with a forward PE of 13.1.
