Hydro One (TSX:H) is a pure-play electricity transmission and distribution company with minimal exposure to commodity price fluctuations. With around 99% of its business rate regulated, its financials are less prone to commodity price fluctuations and economic cycles. The company has increased its rate base at an annualized rate of 5.1% over the previous six years to $26.5 billion. This expansion has supported its financial growth while driving up its stock price. Over the last five years, the company has returned 132% at an annualized rate of 18.4%.
Continuing its uptrend, the company’s stock price has increased by 11.8% this year amid its healthy first-quarter performance and improvement in broader equity markets. Let’s assess whether Hydro One is a buy at these levels (below $50) by evaluating its first-quarter performance and long-term growth prospects.
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Hydro One’s first-quarter performance
Last month, Hydro One posted an impressive first-quarter performance, with its topline growing by 11.2% to $2.4 billion. Meanwhile, its revenue net of purchased power rose 11% to $1.2 billion. The new OEB (Ontario Energy Board) approved rates, and higher average monthly demand supported its topline growth. The company made $735 million of capital investments during the quarter while putting $423 million of assets into service.
Meanwhile, its OMA (operations, maintenance, and administration) expenses increased by $10 million year-over-year due to higher information technology-related expenditures. The company also experienced increased depreciation, amortization, and asset removal costs amid capital asset growth as it continues to put new assets into service. Additionally, its financing charges increased by around 20% to $592 million, driven by increased long-term debt and a higher weighted average interest rate.
Despite these increased expenses, Hydro One’s net income attributed to common shareholders stood at $358 million, translating into an EPS (earnings per share) of $0.60, a year-over-year increase of 22%. With a solid investment-grade debt rating and healthy liquidity, the company is well-equipped to fund its growth initiatives. Now, let’s look at its growth prospects.
Hydro One’s growth prospects
Hydro One estimates Canada’s energy demand to grow between 120% and 135% from 2021 to 2050. Increased awareness about pollution, government policy changes to drive electrification, and technological development could drive electricity demand, thereby increasing the demand for Hydro One’s services. Amid rising demand, the company continues to expand its asset base with its $11.8 billion five-year capital investment plan, spread from 2023 to 2027. These investments could grow its rate base at an annualized rate of 6.6% to $32.1 billion by 2027.
Along with these growth initiatives, Hydro One has implemented several cost-cutting measures. Additionally, favourable rate revisions and the Bank of Canada’s monetary easing initiatives could support its margin expansions in the years to come. Therefore, the company’s growth prospects look healthy.
Investors’ takeaway
Supported by its stable cash flows from regulated utility businesses and healthy financial growth, Hydro One has raised its dividends at an annualized rate of 5.2% over the last seven years. Its forward dividend yield stands at 2.7% as of the June 10 closing price. Moreover, the company’s valuation appears reasonable, considering it has delivered impressive returns over the last five years. Its NTM (next 12 months) price-to-sales and NTM price-to-earnings multiples stand at 3.3 and 24.4, respectively.
Additionally, economists are predicting two more rate cuts by the Bank of Canada this year. Given its capital-intensive business, these rate cuts could reduce its interest expense, thereby improving its margins. Considering all these factors, I believe Hydro One would be an excellent investment at a price below $50.
