Savvy acquisitions lift Fortis

From June, 2017 TSI Dividend Advisor Issue:

Since 2004, Fortis has successfully used acquisitions to speed up its growth. Generally, we feel it pays to take a skeptical view of firms that use that strategy to fuel their expansion. That’s because hidden problems with new businesses can limit any expected profit increases.

However, Fortis’s focus on well-established, regulated utilities cuts that risk. The steady cash flows from its new operations will also let the company extend its 43-year history of yearly dividend increases.

FORTIS INC. $44 (Toronto symbol FTS; Income Growth Payer Portfolio, Utilities sector; Shares outstanding: 399.8 million; Market cap: $17.6 billion; Dividend yield 3.6%; Dividend Sustainability Rating: Highest; www.fortisinc.com) began supplying electricity to St. John’s, Newfoundland, in 1885. The company is now the main power utility in that province as well as PEI. In the past few years, Fortis has used acquisitions to cut its reliance on Atlantic Canada. In 2004, the company paid $1.5 billion for regulated power companies in Alberta and B.C. It later acquired Terasen (now called Fortis BC Energy), which distributes natural gas to 1.2 million customers in B.C. Fortis paid $3.7 billion for that business.

The company has also expanded outside of Canada. In June 2013, it paid $1.5 billion U.S. for CH Energy Group. It distributes electricity and gas in the Mid-Hudson River Valley of New York State. In August 2014, Fortis purchased UNS Energy for $4.5 billion. This firm operates power plants and distributes electricity and gas in Arizona.

In October 2016, Fortis completed its largest acquisition to date. It paid $7.0 billion U.S. in cash and shares for ITC Holdings Corp. (New York symbol ITC). That firm owns 25,100 kilometres of highvoltage power lines in the U.S. Midwest. Including ITC’s $4.8 billion U.S. debt, the total purchase price was $11.8 billion U.S. Fortis later sold 19.9% of ITC to Singapore’s sovereign wealth fund for $1.2 billion U.S.

Following the acquisition, ITC shareholders own 27% of the combined company. Fortis will stay listed on the TSX, but will now trade on the New York Stock Exchange as well.


Fortis

Due to these new operations, the company’s revenue jumped 87.1%, from $3.7 billion in 2012 to $6.8 billion in 2016. Earnings, too, soared 119.1%, from $329 million to $721 million. Fortis typically sells new shares to help pay for its acquisitions. As a result, earnings per share fell 2.3%, from $1.73 in 2012 to $1.69 in 2013. Per-share earnings rebounded to $1.75 in 2014, and rose to $2.33 in 2016.

In the quarter ended March 31, 2017, earnings jumped 47.9%, to $281 million from $190 million a year earlier. ITC contributed $91 million to those results. Due to more shares outstanding, earnings per share gained just 3.0%, to $0.69 from $0.67. Revenue rose 32.1%, to $2.3 billion from $1.8 billion.

The company has increased its dividend for 43 consecutive years; the current annual rate of $1.60 a share yields 3.6%. In 2016, dividends accounted for 65.7% of Fortis’s earnings, so it still has plenty of room to keep raising its payout. In fact, the additional earnings from ITC will help the company raise its dividend by 6% each year through 2021.

In addition to acquisitions, Fortis plans to spend $13 billion over the next five years to expand its operations. Regulators will probably let the company pass along most of these costs to its customers in the form of higher power rates. In 2016, 97% of its revenue came from its rate-regulated utilities.

Fortis will likely earn $2.48 a share in 2017. The stock trades at a reasonable 17.7 times that estimate.

Fortis is a buy.

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