Canadian Utilities Ltd (TSX: CU) is a Calgary-based multiline utility company. The company is a diversified global enterprise with assets of CAD 20 billion and approximately 5,000 employees engaged in Electricity, Pipelines & Liquids, and Retail Energy. The Electricity Global Business Unit's activities are conducted through two regulated businesses, electricity distribution and electricity transmission, and non-regulated electricity generation and transmission. The Pipelines & Liquids Global Business Unit's operations are conducted through three regulated businesses: natural gas distribution, natural gas transmission, and international natural gas distribution, and one non-regulated business: storage & industrial water. The group's majority of revenue comes from the Canadian market (95.6%), and rest comes from Australia.

Investment Rationale

• A dividend yield of more than 5% and a 48-year dividend growth streak: Canadian Utilities has a consistent track record of dividend payment with decent growth over the last 48-years. The group declared a dividend of CAD 0.4354 per share, which was in-line with the previous quarter but 3% higher on an annual basis. Further, at the last traded price, shares of CU were offering a dividend yield of ~5.4%, which is significantly higher, given the low interest rate environment and drying yield income on fixed income securities. Further, CU's dividend yield is approximately 7.28 times of the Canada 10 Year Benchmark Bond Yield of 0758%, and approximately 1.62 times of the TSX 300 Composite Index’s dividend yield of 3.34%.

Source: Company Filings

• Disciplined capital investment approach: Over the years, Canadian Utilities has invested billions of dollars in the regulated utility assets, which is driving its high-quality earnings base and is likely to bolster its balance sheet. Moreover, it also lays a solid foundation for the company to increase its annual dividend consistently.

Source: Company Presentation

• Ample Liquidity: Apart form a healthy cash position of CAD 980 million, the company has strong liquidity levels through its lines of credit amounting CAD 3,048 million with an available balance of CAD 2,260 million. We believe the current liquidity seems sufficient enough to withstand the current downturn.

• Investment grade credit rating: Credit ratings are extremely important because they convey the risk associated with buying a certain stock. An investment grade credit rating indicates a low risk of a credit default, making it an attractive investment vehicle primarily to the conservative investors. In the case of Canadian Utilities, the company has maintained “A-” rating by Standard & Poor’s; and “A” rating by DBRS Limited. Companies with these ratings are considered to be stable entities with robust capacities for repaying their financial commitments. Further, the company’s Net Debt/EBITDA ratio stood at 2x.

Source: Company Presentation

• Technical indicators are signalling a buy: On the daily price chart, a buy technical indicator is forming, with the stock price is about to crossover the crucial short-term as well as long-term support levels of 50-day and 200-day moving averages. A crossover above the crucial resistance can act as a breakout in the stocks. One can closely monitor these breakout levels and go long. Moreover, the Moving Average Convergence Divergence (MACD) also indicating a buy signal, as the MACD oscillator is rising with the difference between 12-day and 26-day EMAs is positive and oscillating above the 9-day SMA signal line, which is a bullish technical indicator.

Source: Refinitiv (Thomson Reuters) 

• Risks Associated with Investment: Canadian Utilities has operations in several jurisdictions subject to emission regulations, including carbon pricing, output-based performance standards, and other emission management policies. The company's business is exposed to a variety of business and financial risks. The outbreak of COVID-19 is also posing a risk to the company's operations, and these risks include a decline in the consumer demand, increase in operating costs, interruption of the project work. The credit risks associated with the business are customer non-payment and change in the timing of cash flows. However, in the second quarter of FY20, the company's operations, financial position and performance have not been impacted significantly by COVID-19 pandemic.

3QFY20 Highlights:

Source: Company Filing

• Canadian Utilities achieved adjusted earnings of CAD 76 million in the third quarter of 2020, compared to CAD 106 million in the third quarter of 2019. Lower earnings this quarter was mainly due to the sale of the Canadian electricity generation business in the third quarter of 2019, and the sale of Alberta PowerLine in the fourth quarter of 2019. These businesses contributed CAD 37 million in adjusted earnings in the third quarter of 2019.
• Excluding the foregone earnings from the businesses that were sold, Canadian Utilities earnings in the third quarter of 2020 were CAD 7 million higher compared to the third quarter last year. Higher earnings were mainly due to Storage and Industrial Water earnings, higher earnings in Electricity Generation from cost efficiencies, as well as higher earnings from the company’s Alberta retail energy business.
• Further, the group gas declared a fourth quarter dividend on October 8, 2020, of 43.54 cents per share or CAD 1.74 per Class A non-voting and Class B common share on an annualized basis.
• On September 30th, the group has entered into an agreement to acquire the 130-kilometre Pioneer Pipeline for a purchase price of CAD 255 million. This agreement replaces the previously announced purchase and sale agreement, whereby NOVA Gas Transmission Limited, or NGTL, was to have purchased the pipeline under substantially similar terms. Canadian Utilities and NGTL agreed that they would transfer to NGTL a 30-kilometre segment that is located within their service territory. However, the transaction is subject to regulatory approvals by the AUC and the Alberta Energy Regulator, which are expected by the second quarter of 2021. If approved by the regulators, this Pioneer transaction would add a net CAD 200 million to Natural Gas Transmissions’ current rate base of about CAD 2 billion.
• The group’s total capital investment in the first nine months of 2020 was CAD 659 million, or CAD 193 million lower than the same period in 2019. Lower capital spending was mainly due to the completion of construction on Alberta PowerLine in 2019, as well as a delayed capital investment in the Utilities. Also, the group do not expect to invest the previously disclosed CAD 1.2 billion in the capital in 2020, due to COVID-19 pandemic and the oil price collapse.

 Segment Highlights

UTILITIES

Source: Company Filing

Lower adjusted earnings were mainly due to the adverse earnings impact of the five-year Access Arrangement regulatory decision and adjustment for the impact of forecasted inflation rates in International Natural Gas Distribution, as well as the transition to Alberta PowerLine operating activities by Electricity Transmission in 2019. Lower earnings were partially offset by ongoing cost efficiencies and rate base growth across the Utilities, and contributions in International Electricity Operations from the 50 per cent joint venture ownership in LUMA Energy, LLC.

ENERGY INFRASTRUCTURE

Source: Company Filing

Lower adjusted earnings were mainly due to the sale of the Canadian fossil fuel-based electricity generation business and Alberta PowerLine in 2019. However, excluding the earnings impact from the sale of these businesses in 2019, adjusted earnings in the quarter were CAD 4 million higher than the same period in 2019. Higher earnings were mainly due to timing and demand for natural gas storage services, and higher earnings in Electricity Generation from cost efficiencies

Stock Performance

In a year-over period, its shares have registered a 52W High of CAD 42.97 on 5-March-2020, and a tested a 52W Low of CAD 25.25 on 23-Mar-2020. At the last closing price of CAD 33.23, its shares traded approximately 25% below the 52W High and approximately 28% above the 52W Low price level. CU shares are still featuring a negative price return of ~ 15% on a YoY basis. 

1-Year Price Performance (as on December 11, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 12.63% of the total shareholding. TD Asset Management Inc. and BMO Asset Management hold the maximum interests in the company at 2.85% and 2.23%, respectively. Further, eight out of top-10 shareholders have increased their stake in the company, with Norges Bank Investment Management (NBIM) and Mackenzie Financial Corporation are among the top investors in the company those have increased their stakes by +1.0 million and +0.21 million, respectively. The institutional ownership in the CU stood at 17.7%, and ownership of the strategic entities stood at 0.43%.

Source: Thomson Reuters, Refinitiv

Note: All forecasted figures have been taken from Thomson Reuters.

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation: The group’s performance in the third quarter of 2020 was moderate, owing to the foregone impact of businesses that were sold. Excluding the forgone earnings from the businesses that were sold, Canadian Utilities earnings in the third quarter of 2020 were CAD 7 million higher compared to the third quarter last year.

Usually, Utilities business are safe investment options as these are mostly regulated and remain steady regardless of the economic condition. Also, business models of the utility companies have assured revenues and offer strong dividend yields too. Canadian Utilities has the longest history of uninterruptedly increasing its dividends for 48 years in a row, the highest by any publicly listed Canadian company.  The primary reason behind its robust dividend payments is its high-quality earnings base supported by rate-regulated utility assets. Canadian Utilities’ 95% of the earnings come from the regulated utility business. Meanwhile, the rest is derived from assets with long-term contracts.

Source: Company Presentation

Over the years, Canadian Utilities has invested billions of dollars in the regulated utility assets, which is driving its high-quality earnings base and is likely to support future dividend payments. Moreover, it also lays a solid foundation for the company to increase its annual dividend consistently. The company is exploring new avenues across the U.S. and in Latin America for its utility segment.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a "Buy" recommendation at the closing price of CAD 32.23 December 11, 2020.

Source: Refinitiv (Thomson Reuters)

 

*Recommendation is valid at December 14, 2020, price as well.

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