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Inside the Market The worst is over for utilities. Here are three stocks to jump on

Algonquin Power & Utilities Corp.’s 2.6 MW Riviere-du-Loup hydroelectric generating facility near the town of Riviere-du-Loup, Quebec, 2010.

Algonquin Power

It was a mixed year for income investors. As rates rose in both Canada and the U.S., prices of interest-sensitive stocks declined and bond funds slipped in value.

GIC investors gained ground, if only marginally. The big banks showed themselves to be more interested in widening their net interest margin than in increasing payments to investors, but rates have gradually edged higher recently.

And, somewhat surprisingly, those holding units in real-estate investment trusts saw some modest gains during the year. Between Dec. 20, 2017 and Dec. 19, 2018, the S&P/TSX Capped REIT Index advanced 2.7 per cent. That’s not a lot but it was much better that the S&P/TSX Composite, which is deep in negative territory.

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One of the areas hardest hit over the past 12 months was utilities, which is traditionally a favourite of income investors seeking a combination of low risk and strong cash flow. Last year, the S&P/TSX Capped Utilities Index stood at 250.32 on Dec. 20. As of the beginning of November, it had tumbled all the way to 217.79, for a loss of 13 per cent in a sector that is normally quite stable. That is well into correction territory, and the drop was reflected in across-the-board retreats in the prices of Canadian utilities stocks.

But the worst may be over for utilities. Since the early November low, the index has moved up by 1.5 per cent and we could see this uptrend continue into 2019.

There are several reasons for this. For starters, the pace of interest rate increases may slow dramatically in 2019. The central banks are playing it cool so far but there are indications that a slowing economy, stock market jitters, and concerns over an escalating trade war between China and the U.S. may cause the Federal Reserve Board to ease off the gas pedal in 2019. In Canada, the economic slowdown in Alberta is an added reason to go slow.

If this scenario materializes, we could see our recommended utility stocks gain more ground in 2019, which would make them a value buy at current prices. Here are three to keep an eye on. Prices are as of Dec. 21.

Fortis Inc. (FTS-T)

Type: Common stock

Current price: $45.82

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Annual payout: $1.80

Yield: 3.9 per cent

Risk rating: Conservative

Comments: Back in February, I wrote a column on the decline of Fortis share prices. In it, I replied to a reader who was concerned. No, Fortis hadn’t suddenly become a bad company, I explained. It was simply reacting to rate hikes, the way almost all interest-sensitive stocks do.

At the time the shares were trading in Toronto at $42.55 and yielding 4 per cent. They dropped a little lower than that, hitting $39.38 later the same month, but that was the nadir. They have slowly but steadily been clawing higher since that time and were trading on Dec. 21 at $45.82.

All the while, the company has continued to perform well, turning in respectable financial results.

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Third-quarter adjusted net earnings attributable to common equity shareholders were $276-million (65 cents per share), compared to $254-million (61 cents per share) for the same period in 2017. This takes account of a $24-million acquisition break fee received in the third quarter of 2017.

Year-to-date adjusted net earnings were $809-million ($1.91 per share), compared to $794-million ($1.92 per share) for the same period in 2017. This adjusts for a favourable one-time $30 million tax remeasurement in 2018, the $24-million acquisition break fee received in 2017, and an $11-million favourable settlement of matters pertaining to the Federal Energy Regulatory Commission ordered transmission refunds in 2017.

Earlier, the company announced an ambitious five-year capital investment plan of $17.3-billion for the period 2019-2023. That was up $2.8-billion from the prior year’s plan. The company projected that its consolidated rate base is projected to increase from $26.1-billion in 2018 to approximately $32-billion in 2021 and $35.5-billion in 2023. That translates into a three- and five-year compound annual growth rate of 7.1 per cent and 6.3 per cent, respectively.

Expansion plans are all very fine, but what income investors want to know about is their returns. At the same time as the capital plan was unveiled, Fortis announced a 5.9-per-cent increase in the quarterly dividend to 45 cents per share ($1.90 annually). This is the 45th year in a row that the company has increased its payout.

Moreover, Fortis extended its average annual dividend growth target to 6 per cent until 2023.

Action now: Buy. Fortis shares have bounced off their lows but are still trading below their all-time high of $48.03 reached in November 2017.

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Emera Inc. (EMA-T)

Type: Common stock

Current price: $43.76

Annual payout: $2.35

Yield: 5.4 per cent

Risk Rating: Conservative

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Comments: We’ve seen a similar pattern in the performance of Emera stock. The shares fell through most of 2018, reaching a low of $38.09 in mid-October. But they have been gradually moving up since then although they are still below their 52-week high of $48.19.

Third-quarter results were very good. Adjusted net income was $191-million (82 cents per share), compared with $118-million (55 cents per share) in the same period of 2017.

For the first nine months of the fiscal year, adjusted net income was $504-million ($2.17 per share), compared with $387-million ($1.82 per share) in 2017.

Cash flow for the nine months, before changes in working capital, increased $281-million, or 29 per cent, to $1.2-billion, compared with $956-million in the 2017 period.

“We saw strong quarter-over-quarter increases across all of our operating companies, reinforcing our continuing expectation of strong results for the full year,” said chief executive Scott Balfour. “Our performance in the quarter reflects how well positioned our businesses are to capitalize on the robust growth opportunities we have within the portfolio. During the quarter, we made significant progress in executing our initiatives in Florida, putting the first 145 megawatt of solar into service with the second tranche of 260 megawatt on track for early 2019."

Emera started out as a strictly Canadian company, created in 1998 as a result of the privatization of Nova Scotia Power. However, in the years since, it has expanded into the U.S. and the Caribbean. The biggest purchase was the 2016 acquisition of TECO Energy. Its assets include Tampa Electric, Peoples Gas and New Mexico Gas.

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The division is now called Emera Florida and New Mexico and it has been a huge contributor to the company’s bottom line. In the third quarter, Emera reported adjusted net income of $140-million from this operation, out of a total of $191-million for the entire company. Clearly, this is a very different operation today compared to its start 20 years ago.

Shareholders are reaping the benefits. In November, the company implemented a 4-per-cent dividend increase, to 58.75 cents per quarter ($2.35 per year), from 56.5 cents per quarter ($2.26 per year) previously. At the new rate the stock yields 5.4 per cent.

The company also revised its annual dividend growth rate target to a range of 4-5 per cent through 2021.

Action now: Buy. The U.S. expansion has turned out to be highly successful for Emera and investors can look forward to continuing dividend hikes for the next several years.

Algonquin Power and Utilities (AQN-T)

Type: Common stock

Current price: $13.86

Annual payout: 51.28 US cents

Yield: 5 per cent

Risk: Higher risk

Comments: Algonquin is technically based in Oakville, Ont., but most of its assets are in the U.S. The company is focused on sustainable power with a portfolio that includes wind, solar, hydro-electric, and thermal. It has over 70 power generating facilities with about 1.7 GW of installed capacity and employs about 2,300 people.

As we have seen with the other utility stocks, rising interest rates hit Algonquin’s share price hard, although the timing was a little different. In this case, the stock bottomed out in April at $12.18 on the TSX. It then bounced around in a fairly narrow trading range until mid-October, when it started a clear upward trend.

Third-quarter results were somewhat mixed. Revenue was US$366.5-million, up 4 per cent from the same period last year. (Note that the company reports in U.S. dollars.) For the first nine months of the fiscal year, revenue was $1.2-billion, a 10-per-cent improvement over 2017.

Adjusted net earnings were down 4 per cent for the quarter to $49.7-million. On a per share basis, the decline was 23 per cent, from 13 cents per share in 2017 to 10 cents per share this year. But for the nine months, it was a different story. Adjusted earnings were $241.6-million (52 cents per share) compared to $158-million (41 cents per share) last year.

Earlier this year, the company announced a 10-per-cent dividend increase, bringing the quarterly payment to 12.82 US cents per share (just over 51 US cents) for a yield of 4.8 per cent. Algonquin has increased its dividend every year since 2010.

On Dec. 14, the company announced an institutional offering of about 12.5 million new shares at a price of $13.76. The sale will generate gross proceeds of about $172.5-million, part of which will be used to partially finance the company’s recently announced acquisition of Enbridge Gas New Brunswick Limited Partnership. The rest is designated “for general corporate purposes.”

Often, a stock will move down in price on news of a new share issue but that has not been the case here. Algonquin shares held their value after the announcement, a good sign for investors.

Action now: Buy. The company has a good history of dividend increases and the Enbridge Gas acquisition will add an important new element to the portfolio.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters.

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