Winning power play for blue chip stock

Fortis Inc. has agreed to acquire U.S. stock ITC Holdings. This company will cost a lot. But ITC should also add a lot to Fortis’ earnings and growth potential. Fortis remains a buy for attractive and growing dividends as well as long-term share price gains.

St. John’s Newfoundland-based Fortis Inc. (TSX─FTS), one of our Key stocks, has agreed to acquire U.S. stock ITC Holdings. The market knocked down Fortis’ share price. That’s because it’s a large transaction. Also, Canadian stocks often get into trouble in the U.S. Even so, we rate Fortis a buy for high and rising dividends plus long-term share price gains. Its dividend of $1.50 a share yields over 3.9 per cent. The company is a dividend aristocrat that has raised its dividend for 42 years in a row.

ITC owns and operates high-voltage transmission facilities in Illinois, Iowa, Kansas, Michigan, Minnesota, Missouri and Oklahoma. Its peak load of over 26,000 megawatts is delivered through 15,600 circuit miles of transmission line. Fortis president and chief executive officer Barry Perry said, “ITC not only further strengthens and diversifies our business, but it also accelerates our growth.”

The offer price is hefty and a moving target

Fortis agreed to pay cash of US$22.57 and 0.752 of its shares for each share of U.S. stock ITC. This will cost Fortis about US$6.9 billion—based on its share price before the proposed transaction was unveiled. But its offer price is a moving target. It will also assume ITC’s debt of US$4.4 billion. The total value of the acquisition is US$11.3 billion.

Fortis’ offer was initially worth US$44.90 for each share of ITC. But the drop in Fortis’ share price has reduced the value of the offer. Multiply Fortis’ price of C$38 a share by 0.752 and the equity is worth C$28.58. That works out to US$20.63 a share. Add the cash of US$22.57 and the offer is now worth US$43.20 per ITC share.

The value of Fortis’ offer will fluctuate with its share price and the exchange rate between the American and Canadian dollars. That is, the offer is a moving target. But one thing that may reassure ITC shareholders is that Fortis will list its shares on the New York Stock Exchange.

We calculate that Fortis’ net debt-to-cash-flow ratio is a hefty 7.1 times. The cash payment will add to its debt. Then again, the issuance of shares will add to the company’s equity. In addition, it plans to sell 19.9 per cent of ITC to minority shareholders. This will reduce Fortis’ financial risk.

The credit-rating agencies appear on board. Fortis writes, “The financing of the Acquisition has been structured to allow Fortis to maintain a solid investment-grade credit rating and is consistent will Fortis’ existing capital structure.”

Dividend aristocrat aims for 6 % annual increase

Fortis expects the acquisition to add five per cent to its earning per share in the first full year. With the transaction expected to close by the end of 2016, it should add to its earnings in 2017. This should assist the company in meeting its target of raising its dividend by an average rate of six per cent through 2020.

Fortis sees ITC’s significant growth opportunities. It writes, “There is a significant need for capital investment in the aging U.S. electric transmission sector.” Fortis expects ITC’s average rate base to grow at an average yearly compound rate of 7.5 per cent through 2018. Fortis also sees a need for investment in new transmission “to facilitate the delivery of electricity from renewable energy sources”. If the U.S. it to reduce its greenhouse gas emissions, it will need to shift from ‘dirty’ energy such as coal to ‘clean’ energy, such as wind, solar and tidal plants.

ITC is regulated by the Federal Energy Regulatory Commission, or FERC. This is a plus. Fortis writes that FERC is “one of the most consistently supportive utility regulators in North America providing reasonable returns and equity ratios.”

Fortis expects ITC to generate nearly 40 per cent of its regulated operating earnings. Due to the issuance of shares, ITC shareholders will end up owning about 27 per cent of the combined company. That seems reasonable given ITC’s large earnings contribution and its growth potential.

 

The Investment Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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