Buy Atco for capital gains and rising dividends

Atco Ltd. has slumped due to rising interest rates in the U.S. But the shares of this blue chip utility stock look cheap relative to their expected earnings of $3.05 and $3.45 a share this year and next. And a compensation payment from Alberta for shuttering a coal-fired generating station early will assist this dividend aristocrat in continuing to raise its dividends each year.

We regularly review Calgary-based utility stock Atco Ltd. (TSX—ACO.X) in The Investment Reporter. Since we published our August 5 issue, its shares have fallen by 12.6 per cent. That partly reflects a recession in Alberta after energy prices fell. More importantly, rising interest rates have hurt utilities in two ways. First, they make stocks that pay high dividends relatively less appealing. Second, higher interest rates make it more costly for utility stocks to carry their debt loads.

U.S. President-elect Donald Trump plans to invest $1 trillion into American infrastructure and cut income taxes. As a result, the Federal Reserve (the U.S. central bank) may have to raise interest rates to meet its mandate to offset inflation and limit price increases to one to two per cent a year.

Higher interest rates could hurt the U.S.

The trouble is, higher interest rates would likely send the U.S. dollar up even higher. This, in turn, would lead to fewer costly exports and more cheap imports. A worsening trade deficit will do nothing to reach Mr. Trump’s vow to ‘make America great again’. In fact, high costs may convince more companies to shift labour-intensive jobs overseas.

Just remember that stocks can beat bonds in times of moderate inflation. After all, companies can raise their prices and earn more. Also, Atco has raised its dividend each year for decades. This growing stream of income can offset inflation. Growing dividends will encourage income-seeking investors to bid up Atco’s share price in the long run, if not in the short.

Atco’s Sheerness Generating Station was initially set to retire its units one and two in 2030 and 2040, respectively. Now the company has agreed to eliminate coal-fired emissions by no later than New Year’s Eve, 2030. It hopes to switch its stations to cleaner natural gas and hydro electricity production. To compensate Atco for the capital invested in Sheerness, the Government of Alberta will pay it $4.7 million for 14 years—or $65.8 million in total.

On October 18, Atco said that it plans to build Western Canada’s largest off-grid solar power station. It will generate up to 75 kilowatts and store 250 kilowatt hours of energy. The project will provide all the power needed by Atco’s new telecommunications facility northwest of Grande Prairie, Alberta.

We continue to rate Atco a buy. That’s because it’s expected to earn more money this year and next. In 2016, the company is expected to earn $3.05 a share. That’s up by nearly a fifth from $2.55 a share last year. In 2017, its earnings are expected to rise by 13.1 per cent, to $3.45 a share. Based on this estimate, Atco recently traded around an attractively-low price-to-earnings ratio of 12.2 times. Its growing earnings support share dividends that yield about 2.7 per cent.

Atco Ltd. is a buy for long-term price recovery as well as attractive, growing dividends.

 

This is an edited version of an article that was originally published for subscribers in the January 6, 2017, 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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