Today, we look at a Canadian blue chip stock that has raised its dividend every year for the past 42 years. Fortis pursues an ambitious policy of growth by acquisition and we look at how the company aims to cushion the risk inherent in this approach.   

Thanks to a series of strategic acquisitions, Fortis’s assets have jumped from $4.6 billion in 2005 to $28.0 billion today.

Expanding by acquisition is usually riskier than internal growth. That’s because new businesses often come with unexpected problems and costs that can offset the extra revenue and earnings they bring. Fortis cuts this risk by targeting established regulated utilities with predictable cash flows.

The company plans to keep buying utilities that can benefit from its expertise, especially as today’s low interest rates cut its borrowing costs. At the same time, it’s investing in its current facilities, which will further spur its earnings growth.

FORTIS INC. (Toronto symbol FTS; www.fortisinc.com) began supplying electricity to St. John’s, Newfoundland, in 1885. The company is now the main power utility in Newfoundland and PEI.

In the past decade, Fortis has used acquisitions to expand to other parts of Canada. In May 2004, it paid $1.5 billion for regulated power companies in Alberta and B.C. In May 2007, it added Terasen (now called Fortis BC Energy), which distributes natural gas to nearly one million customers in B.C. Fortis paid $3.7 billion for this business.

The company is also buying utilities outside Canada. In June 2013, it paid $1.5 billion U.S. for CH Energy Group, which delivers electricity to 300,000 clients in New York State’s Mid-Hudson River Valley. CH doesn’t own power plants; instead, it buys power from other producers. It also distributes natural gas to 77,000 users.

In addition, Fortis paid $4.5 billion for UNS Energy in August 2014. UNS operates power plants and distributes electricity and gas to 658,000 clients in Arizona.

As part of the deal, Fortis will pay an extra $200 million U.S. to help UNS fund its planned purchases of two gas-fired plants. That will lower UNS’s reliance on coal, which accounts for about 60% of its fuel needs.

Blue chip stock: Fortis collects $403 million with the sale of real estate business

Thanks to these purchases and investments in power companies in the Caribbean, Fortis now gets a third of its revenue and 25% of its earnings from outside Canada.

The company’s revenue hovered around $3.7 billion between 2010 and 2012, but acquisitions pushed it up to $4.05 billion in 2013 and $5.4 billion in 2014.

Earnings fell 2.4%, from $375 million in 2010 to $366 million in 2011. Per-share earnings declined at a faster pace of 6.1%, from $1.81 to $1.70, on more shares outstanding. Earnings then rebounded to $371 million (or $1.65 a share) in 2012 and rose to $400 million (or $1.73 a share) in 2013.

Costs to integrate new businesses cut Fortis’s earnings to $385 million (or $1.40 a share) in 2014. Without unusual items, per-share earnings gained 6.5%, to $1.81 in 2014 from $1.70 in 2013.

Fortis recently agreed to sell its real estate operations for $430 million. These properties, located in New Brunswick, Nova Scotia and Newfoundland and Labrador, include 10 office buildings, one mixed-use office complex and three shopping centres. The company expects to complete the sale in the third quarter of 2015.

Meanwhile, Fortis continues to upgrade its current operations. It recently completed a $900-million expansion of the Waneta hydroelectric plant in B.C. Fortis owns 51% of this addition, which is next to the main dam, while the B.C. government holds the remaining 49%. The company has a 40-year deal to sell the power from this expansion to B.C. Hydro, which cuts the project’s risk.

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Regulators likely to let Fortis raise power rates to cover costs and reduce debt

The Waneta project is part of Fortis’s plan to spend $9 billion on its operations between 2015 and 2019. About half of this sum will go to improving the reliability of its power plants, and the other half will go toward new growth projects and equipment.

Fortis will probably borrow the money it needs for these investments. That will add to its long-term debt, which stood at $11.1 billion on March 31, 2015. That’s 11% more than Fortis’s market cap.

However, regulated businesses account for 93% of the company’s assets, and regulators will likely let it raise power rates to cover these costs and pay down debt.

As well, steady cash flows from its regulated businesses continue to give Fortis more room to increase its $1.36-a-share dividend, which yields 3.8%. The company has raised its payout annually for the past 42 years.

The stock has gained 30% in the past five years and now trades at 17.5 times the $2.06 a share Fortis will probably earn this year.

However, its 2016 earnings should improve to $2.17 a share as it realizes more benefits from its recent acquisitions. The stock trades at 16.6 times that forecast.

These are reasonable multiples in light of Fortis’s high-quality assets. The company also gets most of its power from hydroelectric plants, so it’s well positioned to comply with potentially tougher restrictions on greenhouse gas emissions.

What’s more, earnings from Fortis’s U.S. operations will benefit from the weaker Canadian dollar.

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