Over the past three years, the Bank of Canada consistently lowered interest rates. But higher oil prices forced it to raise rates by 25 basis points, to 2.5%, last week.
What’s more, BoC said it might keep raising rates if inflation remains elevated over the next 12 months.
Given this backdrop, does it make sense to own dividend stocks right now, when safer fixed-income assets offer an attractive yield?
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How do higher interest rates affect Canadian dividend stocks?
Government of Canada 10-year yields climbed above 4% on Oct. 1, a three-year high. They have since eased to about 3.8%, but are still 0.75 percentage points higher year-over-year.
When safe bond yields are on the move, a dividend stock has to work harder to be attractive to investors.
What should you look for in a dividend stock when interest rates rise?
I would run every potential dividend stock investment through three key checks:
- Dividend growth: A stock yielding less than a bond can still win if the payout keeps rising.
- Payout ratio: A sustainable payout ratio allows the company the flexibility to lower debt, target acquisitions, and raise dividends.
- Predictable cash flow: Regulated or contracted income helps a company generate cash flow across market cycles.
Fortis stock: A 52-year dividend streak meets higher rates
One TSX dividend stock that ticks most boxes is Fortis (TSX: FTS).
On its July 31 earnings call, CEO David Hutchens stated:
“We have demonstrated that we can grow our dividend responsibly, having increased it for the past 52 consecutive years while maintaining a disciplined approach to balance sheet strength.”
Fortis pays a quarterly dividend of $0.64, an increase of 4.1% year over year. In October, its dividend yield was over 3%, which is below the 10-year bond. However, Fortis aims to grow the payout between 4% and 6% through 2030, which enhances the yield-at-cost.
Fortis is on pace to spend $5.6 billion in 2026, which should expand its base of cash-generating assets and drive future cash flows higher.
Management expects rate base, the asset value on which it earns regulated returns, to grow about 7% a year through 2030.
- $350 million is what Fortis has already budgeted for Tilbury in its current five-year spending plan.
- About $2 billion is the total it could invest if the larger expansion goes ahead.
- The project could add roughly $1.65 billion of spending beyond what’s in the plan today.
Notably, over the last 10 years, FTS stock has generated more than 10% returns compounded annually.
What are the risks of buying Fortis as interest rates climb?
Higher rates raise borrowing costs, which will impact Fortis and other utility stocks.
The company’s latest filing cites higher finance costs as a drag on earnings growth. In July, Fortis Alberta sold 30-year debt at 4.92%, well above what older bonds carry.
CFO Jocelyn Perry told analysts the company will weigh all funding options to keep credit metrics in check even as S&P reaffirmed its A minus issuer rating in May.
Are Canadian dividend stocks still worth buying?
A 3% to 4% dividend yield will only beat a bond over time if the payout keeps growing. Fortis, with a long record of raising the dividend, regulated assets, and a visible growth plan, fits that bill. Always check the payout ratio, the growth outlook, and the debt that is due before you invest!
