One way to maintain a balanced portfolio is to own a mix of stocks that both lead and lag the market. We have identified three blue chip stocks in the currently out-of-favour utilities sector. They’re all buys.
Utility stocks have declined 8.1 per cent since the beginning of the year as a result of rising interest rates. As interest rates rise, investors turn increasingly to the bond markets because they can now find bonds with higher yields than before. Utility stocks, in turn, have to offer higher dividend yields to become more competitive with higher-yielding bonds. Their prices, therefore, must come down to provide that higher yield.
That’s what’s been going on this year, and it’s likely to continue so long as interest rates keep rising. The relative unattractiveness of utility stocks under these circumstances is further compounded by the fact that riskier cyclical stocks hold more appeal when economic growth is robust, as it is now. At least over the near term, then, we expect utility stocks to continue to underperform.
But there are risks that could quickly change this outlook. The most obvious one, of course, is the Trump administration’s willingness to impose tariffs to win concessions from its trading partners. Should this brinkmanship result in an escalating trade war, the prospects for economic growth could start to look a lot less appealing. That, in turn, could cause an exodus from cyclical stocks to more defensive issues, such as utilities.
That’s what happened in June. Trade tensions, plus a sudden decline in interest rates, which have since rebounded, caused utilities to outperform the overall market for a while. Utility stocks gained five per cent from June 7 to July 6. Over the same period, the S&P/TSX Composite Index rose by a more modest 1.1 per cent.
Utility stocks have since given up some ground. But the point remains: Your laggards can often come to life just as your leaders turn sour on you. Holding a combination of leaders and laggards, then, can smooth out your portfolio’s volatility and help limit your losses when markets turn.
Here are three utility laggards to buy
Among our Key stocks, all three of our gas and electricity utility stocks remain on buy.
■ Canadian Utilities (TSX—CU) is down 13.4 per cent since the beginning of the year. The company distributes electricity and natural gas. It’s also engaged in power generation and sales, natural gas gathering, processing, storage and liquids extraction.
Canadian Utilities has increased its common share dividend in each of the past 46 years. This helps offset the downward pressure on its stock price during periods of rising interest rates.
Its shares trade at just 14.9 times this year’s forecast earnings of $2.17 a share. Its annual dividend of $1.57 a share yields 4.9 per cent. Canadian Utilities is a buy for growth and income.
■ Emera Inc. (TSX—EMA) is down 9.7 per cent year to date. It’s an energy and services stock that invests in electricity generation, distribution, gas transmission and utility services. It’s well diversified, with operations in Canada, the US and the Caribbean.
Over 90 per cent of Emera’s earnings come from regulated and/or long-term contract utility infrastructure. That helps the company generate steady earnings and cash flows that are expected to support eight-per-cent compound annual growth in the dividend through 2020.
The shares trade for a reasonable 15.0 times this year’s forecast earnings of $2.83 a share. The annual dividend of $2.26 a share yields 5.3 per cent. Emera is a buy for growth and income.
■ Fortis Inc. (TSX—FTS) has declined 8.2 per cent this year. It’s an electricity and gas utility stock. Like Emera, it operates in Canada, the US and the Caribbean.
Fortis reported a 2.1-per-cent year-over-year rise in adjusted earnings to $293 million in its first quarter ended March 31, 2018. Among the factors that contributed to the increase was a strong performance at Tucson, Arizona-based UNS Energy, largely due to the impact of new rates at Tucson Electric Power this year.
Fortis expects its $15.1-billion five-year capital expenditure plan to contribute to growth in the coming years.
The stock trades at a reasonable 16.7 times the $2.54 a share that Fortis will probably earn in 2018. The annual dividend of $1.70 a share yields 4.0 per cent. Fortis is a buy for growth and income.
This is an edited version of an article that was originally published for subscribers in the August 10, 2018, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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The Investment Reporter •9/18/18 •