Interest rates are on many investors’ minds these days as concerns mount that a rise in rates could spell an end to the market’s record run in equities. But if you’re looking for a defensive play that’s more immune to interest rate fluctuations, you might want to look at a Fortis (Fortis Stock Quote, Chart, News, Analysts, Financials TSX:FTS) or Algonquin Power (Algonquin Power Stock Quote, Chart, News, Analysts, Financials TSX:AQN) over a name like Hydro One (Hydro One Stock Quote, Chart, News, Analysts, Financials TSX:H), says portfolio manager Christine Poole, who is cautious about Hydro One’s growth prospects.
“We don’t own Hydro One. It’s very defensive in its cash flow streams, obviously, as it’s in Ontario,” said Poole, CEO of GlobeInvest Capital Management, speaking on BNN Bloomberg on Friday.
“One of the reasons why we own, let’s say, Fortis versus Hydro One is that half of Fortis’ operations come from the US and there’s still a lot of growth,” she said. “I think it’s just the geographical limitation of Hydro One. Where is it going to continue to grow outside of what happens in Ontario? That’s the drawback on owning that stock. So, that’s why we own Fortis over Hydro One.”
All things considered, 2020 was a pretty good year for Hydro One. The botched takeover of US power company Avista was in the rearview mirror and things seemingly were calmer on the management side as well as in terms of operations and company direction, with a new CEO in place and less in the way of front page feuds with its majority shareholder, the Ontario government. Hydro One even negotiated two collective agreements with its employees, putting the company on a more stable footing going forward.
“We are continuing to execute on our strategic plans. We are reducing costs, putting capital to work and generating positive returns for our shareholders,” said CEO Mark Poweska in Hydro One’s most recent earnings conference call, for the company’s third quarter 2020, delivered on November 6. “This positive outlook, combined with our greater purpose of energizing life is attracting high-caliber individuals to our talent force and motivating existing employees to step up.”
Ahead of Hydro One’s fourth quarter report due in the next few weeks the company beat expectations with its third quarter numbers, coming in with revenue of $1.93 billion compared to $1.59 billion a year earlier and net income up 17 per cent to $281 million or $0.47 per share. Analysts had been expecting revenue of $1.86 billion and earnings of $0.42 per share.
The focus for many Ontario residents has been on electricity costs during the pandemic, which have been an issue for businesses feeling the crunch of a stay-at-home economy. The provincial government has worked with Hydro One to initiate rate protections and a ban on disconnections for residents along with subsidies for businesses.
“Hydro One’s team remains dedicated to delivering exceptional service and support to our customers,” said Poweska in the Q3 earnings report. “By focusing on the priorities of the business and executing against our plans, we continue to demonstrate long-term benefits to our customers, employees and shareholders.”
And shareholders had lots to be thankful for in 2020, as well, with Hydro One continuing its multi-year run of positive returns. Despite the pandemic-related pullback of a year ago, Hydro One managed to end 2020 up 14 per cent. That’s on top of a healthy dividend which currently has a yield of 3.6 per cent.
Poole says income earners like the utilities shouldn’t be avoided out of fear of rising interest rates, at least not yet. And having diversity in their business can help a utility, too.
“Everyone’s talking about interest rates right now but they’re still very, very low,” Poole said. “If you look at a chart of ten-year treasuries we’re still at very low levels, so that’s not really a concern for me right now until rates go much higher than here.”
“But one of the buffers to rising interest rates is you want to find a utility that has the business model in place and the capital programs in place to continually increase their dividend annually,” Poole said. “That’s kind of a buffer because at least their dividend is going to continue to go up. If the dividend was flat for the next ten years then, yes, the dividend yield might go down if the share price keeps up a bit or just stays flat.”
How much of your portfolio should be reserved for the slower growth but higher yield names in the utilities space? Poole says
“In terms of utilities as a percentage of client portfolios, right now we allocate probably only five per cent to regulated utilities,” Poole said. “Fortis is one and Algonquin is another. Algonquin also has renewables so that’s a little different. Even though the renewable power producers are in the utility sector and are classified as utilities, it’s a whole different dynamic. So, I wouldn’t put renewables under regulated utilities which are much more sensitive to rising interest rates.”