Take a pass on Hydro One, says Laurentian

Troy Sun of Laurentian Bank Securities is staying cautious on Hydro One (Hydro One Stock Quote, Charts, News, Analysts, Financials TSX:H), as he maintained a “Hold” rating on the stock in an update on Tuesday while raising his target price from $32/share to $35/share.

An Ontario-based electricity transmission and distribution company, Hydro One owns and operates approximately 30,000 circuit kilometers of high-voltage transmission lines and 125,000 circuit kilometers of primary low-voltage distribution network to serve more than 1.5 million residential, small business, commercial and industrial customers.

Sun’s analysis serves as a preview to the company’s upcoming financial results for the first quarter of 2022 on May 5, which Sun expects to be strong for the company, albeit with little discussion relating to capital given the present state of Ontario provincial politics.

“Given what transpired during the last election cycle, we expect management to provide muted commentary on the company’s financial and capital aspirations in Q1/22E,” Sun said. “That being said, we do anticipate lots of questions around the ongoing joint rate application, especially in relation to the stakeholder feedback and technical briefing take-aways.”

In looking ahead to the upcoming results, Sun pointed to the idea of offsets with the first and fourth quarters of 2022, accomplished by bringing forward certain OM&A expenses in the latter half of the year to de-risk future profitability.

Ahead of the company’s financial reports, Sun has made slight revisions to his financial projections, as he now forecasts Hydro One to bring in $1.95 billion in revenue for the opening quarter of 2022 instead of $1.93 billion, though lower expectations for the fourth quarter of 2022 keep the overall year-end forecast at $7.6 billion, with a potential six per cent year-over-year increase to $8.07 billion set as the estimate for 2023.

Sun’s new EBITDA estimates follow a similar path, with an increased first quarter projection ($709 million versus $682 million) being offset by a lower fourth quarter projection ($561 million versus $594 million) to maintain an overall $2.56 billion projection for 2022 to imply a margin of 33.7 per cent. Meanwhile, the 2023 estimate remains set at $2.59 billion to suggest a slightly reduced margin of 32.1 per cent.

From a valuation standpoint, Sun forecasts minimal drops in the company’s EV/EBITDA multiple, falling from the reported 14.1x in 2021 to a projected 13.9x in 2022, then to a projected 13.7x in 2023, slightly off from the cumulative peer group average projection of 11.8x.

Meanwhile, the revised EPS estimates follow the same track with a higher first quarter projection ($0.50/share versus $0.44/share) balanced out by a weaker fourth quarter estimate ($0.29/share versus $0.34/share) to yield an annual EPS estimate of $1.63/share, which increases to a projected $1.66/share in 2023.

Sun also forecasts the company’s P/E multiple to drop from the reported 22.3x in 2021 to a projected 22x in 2022, then to a projected 21.6x in 2023, which comes in slightly behind the cumulative peer group average of 19.7x.

Overall, Sun believes the company has full valuation with its current defensive business model.

“Against an inflationary backdrop with many (largely negative) moving pieces on the macro level, investors are flocking into safe-haven assets (hence why the cyclicals have been battered of late),” Sun said. “That being said, shares at 22.0x 2022E P/E (almost four turns higher than long-term median) appear to be capturing the risk-reward.”

Hydro One’s stock has enjoyed positive momentum to start 2022 with a 6.6 per cent return in the last four months, with a more pronounced climb starting after dropping to a 2022 low of $30.92/share on February 23 and going as high as $35.85/share on Tuesday.

At press time, Sun’s new $35.00 target represented a projected one-year return of negative two per cent.

Hydro One has been busy in the community as of late, partnering with the Ivy Charging Network to allow EV drivers to charge their vehicles at any Ivy charging station for free on Earth Day, while also partnering with the Helping Hand Food Bank in the Bradford-West Gwillimbury area of Ontario to help the food bank offer more halal offerings through its Energizing Life Community Fund, which supports initiatives that promote physical, emotional and psychological safety and well-being.

“At Hydro One, we are deeply committed to supporting organizations working tirelessly to build a better and brighter future for residents,” said Jay Armitage, Vice President, Marketing & Communications, Hydro One in the company’s April 21 press release. “The Helping Hand Food Bank plays a critical role in ensuring residents in the Bradford West Gwillimbury area do not go hungry, and have more inclusive food options to support their psychological well-being.”