Company Profile

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 businesses. 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 Defensive Play: The utility sector, which includes electric, gas and water companies, traditionally offers investors a solid income stream through steady dividend payments, and it also tends to outperform benchmark index on a relative basis during down markets as every phase of the economic cycle relies on water, fuel, and power. This means that the companies, which provide these services generate plenty of cash flow, and since most of the heavy infrastructure has already been built, there is rarely a reason to spend a lot of money on expensive capital programs. As a result, most utilities companies can pass on higher-than-normal rewards back to the shareholders in the form of dividends.

• Consistent Dividend Payment: CU 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 5.31%, which is significantly higher, given the lower interest rate environment and drying yield income on fixed income securities. Further, CU's dividend yield is approximately 11.06 times of the Canada 10 Year Benchmark Bond Yield of 0.48%, and approximately 1.47 times of the TSX 300 Composite Index’s dividend yield of 3.6%, respectively.

Source: Company Filings

• Robust Liquidity and Investment grade Credit Rating: At the end of 2QFY20, CU has maintained enough liquidity to fund approximately one full year of cash requirements, which suggests strong financial flexibility. The multiline utility group’s financial position is backed by utilities and long-term contracted operations, and the primary source of capital is cash flow from operations and supported by appropriate levels of cash and available committed credit facilities. At the end of 2QFY20, the company had CAD 3,034 million in total lines of credit, out of which CAD 553 million was in the form of uncommitted credit facilities with no set maturity and the other CAD 2,481 million with maturities between 2021 and 2023. Further, CU has always maintained a strong investment-grade credit rating, which helps it access funds at a competitive rate. In an exchange filing, CU updated that as on July 20, 2020, Dominion Bond Rating Service affirmed its 'A (high)' long-term corporate credit rating and stable outlook. 

• Risks Associated to Investment: 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.

2QFY20 Highlights:

 

Source: Company filings

In the second quarter of the financial year 2020, the company reported revenue declined by CAD 162 million to CAD 704 million, primarily led by forgone revenue following the sale of the Canadian fossil fuel-based electricity generation business in the third quarter of 2019 and subsequent sale of Alberta PowerLine (APL) in the fourth quarter of 2019.

Source: Company filings

The group’s adjusted earnings for the second quarter 2020 declined by CAD 32 million to CAD 94 million from CAD 126 million reported a year before, due to the disposal of the Canadian fossil fuel-based electricity generation business and 80% ownership interest dilution in Alberta PowerLine in 2019, which together contributed CAD 17 million in adjusted earnings in the second quarter of 2019. Further, regulatory decisions announced in the second quarter of 2019, comprises CAD 15 million in adjusted earnings that were related to the corresponding previous financial year.

Operating costs for the period under review declined by CAD 124 million to CAD 380 million, and net finance costs also lowered by CAD 20 million to CAD 97 million, partially because of lower interest expense under service concession arrangement accounting for APL and lower interest expense on non-recourse long-term debt due to the sale of the Canadian fossil fuel-based electricity generation business. Further, a lower interest cost was also driven by the positive impact of a new interest rate hedging arrangement for International Natural Gas Distribution which became effective at the beginning of January 2020.

Cash positions of the company as on Jun 30, 2020 was CAD 938 million, which was CAD 39 million lower against cash position reported at the end of December 2020.

Business Unit Performance

Utilities:   The utility business unit of the group have no material impact on the adjusted earnings during the quarter under consideration because of COVID-19 pandemic. Utilities adjusted earnings of CAD 111 million in the second quarter of 2020 were CAD 18 million lower than the same period in 2019. Lower earnings were mainly due to the prior period impact of regulatory decisions received in the second quarter of 2019. Utility revenue during the second quarter of 2020, stood at CAD 678 million, CAD 1 million higher on a YoY basis, due to increase in the regulated rate base and partially offset by the timing of settlements related to regulatory decisions and the completion of the PBR efficiency carry-over mechanism (ECM) funding in 2019.

Energy Infrastructure: The energy infrastructure business unit’s revenue slumped by CAD 143 million to CAD 51 million, primarily because of forgone revenue associated with the sale of Canadian fossil fuel-based electricity generation business in the third quarter of 2019 and sale of APL in the fourth quarter of 2019. Energy Infrastructure recorded adjusted earnings of $4 million, $15 million lower than the same periods in 2019.

Stock Performance

At the closing (on August 07^th, 2020), shares of CU traded 1.64% higher at CAD 32.81. In a year-over period, its shares have registered a 52W High of CAD 42.97 on 05-March-2020, and a tested a 52W Low of CAD 25.25 on 23-Mar-2020, and at the last closing price of CAD 32.81, its shares traded approximately 23.64% below its 52W High and approximately 29.94% above its 52W Low price level, reflects is more tilted towards its 52W high price level.

1-Year Price Performance (as on August 07^th, after the market close). Source: Thomson Reuters.

Over the last three months, shares of CU traded approximately 2.34% higher, however, featuring a negative price return on YoY, YTD and month over period.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 13.57% of the total shareholding. TD Asset Management Inc. and The Vanguard Group, Inc. hold the maximum interests in the company at 2.71% and 2.11%, respectively. Further, four out of top-10 shareholders have increased their stake in the company over the last three months, with Norges Bank Investment Management (NBIM) and BMO Asset Management Inc. are among the top investors in the company which have increased their stakes by +1.0 million and +0.27 million, respectively. The institutional ownership in the CU stood at 19.82%, and ownership of the strategic entities stood at 0.43%, respectively.

Source: Thomson Reuters, Refinitiv

Valuation Methodology (Illustrative): EV/EBITDA Based Valuation Metrics

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

Stock Recommendation: The group's operation comes under essential services, hence are immune to the economic cycle. The group's performance in the second quarter of the financial year 2020 and in the first half of the financial year 2020 remain immune against the COVID-19 pandemic. The group has strong liquidity to fund approximately one full year of cash requirements, which shows strong financial flexibility. The group derives around 95% of its adjusted earnings through regulated utilities, which suggests stability in earnings.

The stock has a solid history of dividend payment, which is an important parameter from an income investor's point of view. The group has 48-years track record of consistent dividend payment, which depicts the financial strength of the company. At the last traded price, the stock was offering a dividend yield of 5.31%, which is lucrative considering the prevailing interest rate environment in the economy.

Further, 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.

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 32.81 (August 07^th, 2020, after the market close), with lower double-digit upside potential, based on the NTM Peer's Average EV/EBITDA multiple of 11.87x, on the FY20E EBITDA. We have considered Emera Inc (TSX: EMA), Hydro One Ltd (TSX:H), and Fortis Inc (TSX: FTS) etc., as a peer group for comparison purpose. 

*Recommendation is valid at August 10, 2020 price as well.

*Please be aware dividend is variable and not guaranteed.

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Disclaimer

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