Fortis (TSX:FTS) is down nearly 20% from the 2022 high. Investors who missed the rally off the 2020 market crash are wondering if FTS stock is once again undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) focused on dividend growth and total returns.
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Overview
Fortis is a utility company with $68 billion in assets spread out across Canada, the United States, and the Caribbean. Most of the revenue comes from regulated businesses, including power-generation facilities, electricity transmission networks, and natural gas distribution utilities.
Electricity and natural gas are needed by businesses and households regardless of the state of the economy. This should make Fortis a good stock to use as a defensive holding during economic downturns.
Investors dumped the stock, however, over the past two years as a result of the perceived threat from soaring interest rates.
Utility companies typically use debt to fund part of their growth programs often run in the billions and can take years to complete before they start to generate cash flow. A sharp rise in borrowing costs cuts into profits and reduces cash that can be used for dividends or share buybacks. High financing costs can also make some projects unprofitable. This potentially reduces the growth outlook for the business.
The Bank of Canada recently cut its interest rate by 0.25%. Additional reductions are expected before the end of this year and into 2025 if Canadian inflation holds below 3%. The U.S. Federal Reserve is still waiting for more evidence that inflation is under control and headed to its 2% target. Analysts expect the American central bank to begin cutting rates later this year or in 2025. As soon as rates begin to decline south of the border, there could be a flood of new money back into utility stocks.
Growth
The steady revenue stream coming from the utility assets enables management to plan capital projects over several years. Fortis is currently working on a $25 billion capital program that will boost the rate base from $37 billion in 2023 to more than $49 billion in 2028. As new assets go into service there should be adequate growth in cash flow to support planned annual dividend increases of at least 4%.
Fortis also expands through strategic acquisitions. The company hasn’t made a major purchase for several years, but it wouldn’t be a surprise to see a new deal emerge once borrowing costs decline. Additional cash flow from an acquisition could boost the outlook for distribution growth.
Dividends
Fortis increased the dividend in each of the past 50 years, so the guidance for dividend growth through 2028 should be solid. Investors who buy FTS stock at the current level can get a 4.4% dividend yield and wait for distribution hikes to boost the return on the original investment.
Time to buy FTS stock?
Near-term volatility should be expected until the U.S. Federal Reserve delivers a rate cut and signals that further reductions will follow. In the meantime, investors can buy Fortis at an attractive price and collect a decent dividend yield.
Buying Fortis on large pullbacks has historically proven to be a savvy move for patient investors. If you have some cash to put to work, this stock deserves to be on your radar today.
