CANADIAN UTILITIES LTD. $37 (Toronto symbol CU (old symbol CU.NV); Income Portfolio, Utilities sector; SI Rating: Above average) is one of Alberta’s leading suppliers of natural gas (940,000 customers) and electricity (211,000 customers). It also operates power plants in other parts of Canada, Australia, and the UK, and provides engineering and related services to other gas and power companies.

The company is slowly shifting its focus to its regulated businesses, which supply about half of its revenue and income. While that limits its growth prospects, it greatly cuts its risk and helps provide it with more predictable cash flows.

Canadian Utilities still on a diet

Two years ago, Canadian Utilities sold its retail gas and electric operations. Deregulation opened up this market to competition, and the company decided it would rather focus on its wholesale business.

The company may spin off or sell more assets in the next few months, or convert them into an income trust. These operations supply a quarter of total revenue and earnings, and include its unregulated natural gas processing and storage businesses.

Canadian Utilities’ revenue fell from $3.5 billion in 2001 to $3.0 billion in 2002, due to lower gas and electricity prices. Revenues improved to $3.7 billion in 2003, but the sale of the retail division cut revenue in 2004 to $3.0 billion. In 2005, revenue fell to $2.5 billion, mainly due to the lack of retail sales.

Income rose from $1.86 a share (total $254.1 million) in 2001 to $2.40 a share ($323.2 million) in 2002, due to a $110.1 million pre-tax gain on the sale of an asset. Earnings fell to $2.04 a share ($292.2 million) in 2003, but a $63.3 million pre-tax gain from the sale of the retail division raised income in 2004 to $2.43 a share ($344.8 million). In 2005, it earned $2.08 a share ($301.4 million).

Strong cash flow balances high debt

Canadian Utilities’ cash flow per share grew from $3.83 in 2001 to $4.91 in 2005, or 6.4% compounded annually. This key performance indicator excludes non-cash gains and losses.

The company’s strong cash flow should help fund the roughly $4.50 a share it plans to spend on upgrading its facilities in 2006, up 8.4% from $4.15 in 2005. Most of its non-regulated power plants are less than 10 years old, so capital expenditures should hover around $4.50 a share for the next few years.

However, Canadian Utilities’ cash flow is not enough to fund capital spending, as well as pay its $1.16 a share dividend, which yields 3.1%. So it will borrow to fund these projects. Long-term debt is a high 1.0 times equity, but the company’s high credit rating helps keep its interest costs down.

Potential capital-gains bonus

The stock now trades at 17.1 times its forecast 2006 profit of $2.16 a share. The possibility of a spin-off or trust conversion of a quarter of the company’s asset base provides capital gains potential, since investors often ignore these situations until the sale, conversion or spin-off is imminent.

Canadian Utilities is a buy.