Utilities are supposed to be boring. Bond markets have recently been doing their best to ruin that arrangement. Higher global borrowing costs can hit a utility twice. Debt becomes more expensive, while investors suddenly have better-paying bonds competing with the stock’s dividend.
The International Monetary Fund (IMF) and World Bank meetings arrive next week as long-term government borrowing costs sit near multi-decade highs. That makes a defensive utility’s financing plan almost as important as the electricity it sells. So, where should Canadian investors start to look?
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Essential doesn’t mean interest-proof
Utility customers don’t stop using electricity because bond yields rise. That provides unusually stable demand. Yet utilities also spend billions on generation, transmission and distribution infrastructure. Much of that spending is financed with debt.
So I’d look for two things: regulated projects capable of earning an attractive return and earnings growth strong enough to absorb higher financing costs. Emera (TSX: EMA) offers both the opportunity and a useful warning.
Rates are already showing up
Emera owns regulated electricity and gas businesses in Canada and the United States. Second-quarter adjusted earnings per share (EPS) slipped to $0.69 from $0.79 a year earlier, with higher interest expense contributing to the decline.
That’s exactly why investors shouldn’t buy a utility merely because the customer base is defensive. Emera still invested more than $1.7 billion in customer infrastructure during the first half and maintains an approximately $4 billion annual capital plan.
Management targets 5% to 7% adjusted EPS growth through 2030. That growth can support future dividends if new investments earn enough to cover the cost of financing them.
Income now, growth later
Then there’s the strong and substantial dividend to consider. Emera pays $0.73 quarterly, or $2.93 annually. At roughly $68.37, that produces a yield near 4.3%. Here’s what a $10,000 investment could bring in at writing.
| COMPANY | RECENT PRICE | NUMBER OF SHARES | ANNUAL DIVIDEND | ANNUAL TOTAL PAYOUT | FREQUENCY | TOTAL INVESTMENT |
|---|---|---|---|---|---|---|
| EMA | $68.37 | 146 | $2.93 | $427.78 | Quarterly | $9,982.02 |
For investors hunting Canadian dividend stocks, that starting income is attractive. Coverage needs watching, though. Two quarterly payments total $1.47 per share. Against first-half adjusted EPS of $2.06, the payout works out to roughly 71%. That doesn’t look alarming, but it leaves less breathing room than some lower-yield stocks.
Considerations
Higher borrowing costs, storms, unfavourable regulatory rulings or poorly executed capital projects can weaken Emera’s growth. Utilities can also issue equity to help finance investment, creating dilution if total earnings grow faster than earnings per share.
A TFSA can make the income more useful. Eligible dividends and gains held inside a TFSA generally avoid Canadian tax, assuming sufficient contribution room. It can’t make debt cheaper.
Bottom line
Emera offers exactly what investors often want when the economic outlook gets uncomfortable: essential services and a 4%-plus yield. The latest quarter also shows why I wouldn’t stop there.
If Emera can turn its $4 billion annual capital program into 5% to 7% long-term EPS growth without letting financing costs run away, today’s bond-market pressure could eventually become a useful entry point. The dividend is the income. Execution is what has to make it grow.
