Regulatory risks are still too high with Hydro One, says Industrial Alliance

Strong fundamentals are not enough to move the needle on Hydro One (Hydro One Stock Quote, Chart TSX:H), says Jeremy Rosenfield, analyst for Industrial Alliance Securities, who in a research update to clients Thursday argues that the political and regulatory risks attached to the utility are too great.

Hydro One reported its fourth quarter fiscal 2018 financials on Thursday, featuring revenue of $1.56 billion, up from $1.44 billion a year prior, and a profit of $162 million, up from $155 million a year prior. On an adjusted basis, its EPS was $0.30 per share, which compared to the consensus estimate of $0.29 per share and Industrial Alliance’s $0.28 per share.

Rosenfield says the company’s fundamental growth remains healthy and unchanged at approximately four to six per cent a year of organic rate base growth over the medium term, driven by investments in its Ontario regulated businesses which are likely to translate into similar EPS and DPS growth.

At the same time, the analyst points to a number of regulatory issues that are tied to the company’s part ownership by the Ontario provincial government. These include an executive compensation directive from the province, a directive designating Nextbridge as the proponent to build the proposed East-West Tie transmission line (removing one potential longer-term investment for Hydro One), the decision to terminate the merger between Hydro One and Avista Corp, and a number of other upcoming regulatory decisions related to both the Distribution and Transmission segments.

“We continue to view Hydro One as a fundamentally defensive investment, underpinned by: (1) stable earnings and cash flows from its regulated utility businesses; (2) healthy organic rate base and earnings growth (4-6 per cent/year through 2023); and (3) an attractive dividend (~4.5 per cent yield, 70-80 per cent target payout). However, we continue to see heightened political/regulatory risk as an overhang, outweighing Hydro One’s fundamentals,” says Rosenfield.

The analyst is maintaining his “Hold” rating and price target of $21.00, implying a projected return including dividend of 6.2 per cent at the time of publication.