Fortis (TSX:FTS) is a premier blue-chip stock in the utility sector, boasting an impressive history of half a century of uninterrupted annual dividend increases. With a recent five-year dividend growth rate of 5.8%, Fortis is an example of the stable growth expected from defensive investments. But is it a smart buy for those seeking a reliable 4% dividend yield? Let’s delve deeper.
The defensive appeal of utility stocks
Utility stocks, such as Fortis, are often seen as bastions of stability in an unpredictable market. In the case of Fortis, its essential products — electricity and gas — remain in demand regardless of economic conditions. During recessions, clients still need to power their homes and businesses, making utilities a go-to choice for conservative investors. Fortis’s portfolio is predominantly composed of regulated transmission and distribution assets, providing a steady stream of earnings that tends to weather economic downturns.
Over the past two decades, Fortis has shown remarkable resilience, experiencing only four years of earnings decline. These declines were minor, with three years reflecting a drop of around 1%, and one year experiencing a 6% decline. Notably, the company’s earnings rebounded strongly the following year, underscoring its defensive nature. For risk-averse investors, Fortis represents a solid addition to any portfolio, offering the promise of stability amidst market turbulence.
Evaluating dividend sustainability
At a recent share price of approximately $62, Fortis stock provides a dividend yield of nearly 4%. This yield is not only attractive but also appears secure, supported by a payout ratio of about 74% of its adjusted earnings per share and 75% of its diluted earnings per share this year. The company’s commitment to maintaining dividends is backed by its consistent earnings predictability, though it faces challenges in a rising interest rate environment.
Historically, Fortis has been able to increase its dividends annually, with the latest hike reflecting a 4.2% increase. However, the near-term dividend growth rate might be capped around 4%, despite the company guiding for a rate of 4-6%. Investors should be mindful that while the current yield is appealing, the stock comes with some valuation risks at today’s price levels. The stock trades at a long-term price-to-earnings ratio of approximately 19.3, which is in line with its historical averages, suggesting it may be fully valued at present.
Timing the market: A strategic approach
Investors typically seek to acquire stocks at a discount for a better margin of safety. Fortis has recently navigated a higher interest rate environment, which led to it trading below $52 per share earlier this year — representing a P/E of around 16.6, or about 14% below its fair value. This was a prime opportunity for those looking to capitalize on Fortis’s strong fundamentals.
Currently, as interest rates appear to have stabilized, the stock’s pricing has adjusted accordingly. For income-focused investors willing to accept a 4% yield with the potential for modest growth, Fortis can be a good choice. However, for those prioritizing total returns or greater security for their investment, it may be wise to explore alternatives or wait for a more favourable entry point.
The Foolish investor takeaway
Fortis may be a good candidate for conservative investors seeking reliable income through its 4% dividend yield. With a strong history of dividend growth and resilience during economic downturns, it is well-positioned within the utility sector. However, potential investors should remain cautious about current valuation levels and consider waiting for a pullback before entering.
