Fortis (TSX: FTS) is up about 8% since the start of the year. Investors who missed the bounce are wondering if FTS stock is undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) focused on dividends and long-term total returns.
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Fortis share price
Fortis trades near $64.50 at the time of writing. The stock has been on a choppy ride for much of the past five years, trading in a range of roughly $50 to $65 per share.
Interest rate changes in Canada and the United States caused most of the turbulence. Fortis and other utility stocks use significant levels of debt to help fund growth projects that often cost billions of dollars and can take years to complete. Big moves in the cost of borrowing can, therefore, have an impact on debt expenses, with higher interest charges reducing profits and cutting into cash that could be paid out to shareholders or used to strengthen the balance sheet. Elevated borrowing costs can also make some potential capital projects unattractive due to the reduced return. That can put pressure on the growth outlook.
The Bank of Canada and the U.S. Federal Reserve started to aggressively raise interest rates in the second half of 2022 and continued raising rates through much of 2023. This drove money out of utility stocks as investors stepped aside to see how long it would take to get inflation under control. Fortis saw its share price slide from $65 in the first half of 2022 to as low as $50 and remained under pressure until the summer of last year when the Bank of Canada began to reduce interest rates. That triggered the start of a rebound for utility stocks that picked up momentum when the U.S. Federal Reserve started to cut rates, as well.
Growth
Fortis operates power generation, electricity transmission, and natural gas distribution businesses in Canada, the United States, and the Caribbean. The company has a good history of driving growth through a combination of acquisitions and organic projects. Fortis hasn’t done a large deal for several years, but consolidation in the sector could pick up again as interest rates decline. In the meantime, management is focused on the current $26 billion capital program that is expected to boost the rate base from $39 billion in 2024 to $53 billion in 2029.
As new assets are completed and go into service, the bump in revenue and cash flow should support planned annual dividend increases of 4-6% through 2029. Fortis raised the dividend in each of the past 51 years, so investors should be comfortable with the guidance.
At the time of writing, FTS stock provided a dividend yield of 3.8%.
Risks
The rally that occurred over the past nine months has been driven by expectations of steady rate cuts by the Canadian and American central banks. Canada will likely continue to lower interest rates, even amid a spike in inflation, due to economic weakness. If the U.S. imposes and maintains widespread tariffs, there could be a spike in inflation in America that would potentially force the U.S. Federal Reserve to start raising interest rates again instead of trending lower. In that scenario there would likely be new pressure put on the share prices of utility stocks.
Is FTS stock a buy?
Near-term volatility should be expected until there is more clarity on U.S. trade policy, so I wouldn’t back up the truck at this point.
That being said, investors who already own the stock should probably hang onto the position and look to add on a dip. Fortis should be a solid pick on any weakness for a buy-and-hold portfolio focused on dividend growth.
