It’s not often we dive into investor day presentations or even take deep dives into regulated utility quarterly reports. The companies are so stable and produce such predictable cash flow that they’re often best left to do their own thing while you focus on improving other sections of your portfolio.

However, utilities have been faced with some significant headwinds as of late. We feel it is important to look into the investor presentations of arguably the two most prominent utility companies featured here at Stocktrades, Fortis and Brookfield Renewable.

Before we get into that, we have a Bull List removal to announce.

We’ve removed TD Bank (TSE:TD) from the Bull List

A note before we start here: Mat and Dan both own TD Bank and have zero plans to sell. Dan maintains an equal weight position in all 3 of his banks, Royal, TD, and Bank of Montreal, and will continue to deploy that strategy moving forward.

If you’ve been a member here for a reasonable amount of time, you know we tend to maintain what we feel is the most attractive Big 6 bank on the Dividend Bull List. Why? If we have more than one, we are constantly presented with the question of “which one would you choose?” This helps us answer that.

Again, we cannot state enough, this is no reason to sell TD. It is just a way to simplify things and remove confusion.

We’ve talked many times about the pressures that financials face in the coming years, banks in particular. This rapid pace of interest rate hikes and persistent inflation will be a headwind for the foreseeable future.

Earlier this year, some called for rate cuts by the end of 2023 or early in the new year. That narrative has changed significantly, and now, the expectation is higher rates for longer.

That said, why keep BMO over TD? Both are trading at similar valuations against historical averages, both dividends are well covered, and both have decent sized exposure to the U.S. market.

There are two differentiations. First, BMO was able to close on its transformative Bank of the West acquisition, while TD walked away from its First Horizon deal. Already, it looks like BMO will be in a strong position to benefit from their big U.S. deal. At the same time, there are some concerning accusations towards TD re: money laundering.

As a result, TD is now under investigation by the SEC. First Horizon has also launched a lawsuit against TD Bank after it walked away from the deal. While it may amount to a small fine and perhaps some minor restrictions, these situations lead to uncertainty and the markets get skittish when things aren’t clear.

Secondly, while both banks are exposed to negative amortizations, BMO’s residential mortgage exposure is far lower than TD Bank’s. In fact, at 31%, it is the lowest among the Big 6 Banks.

Any questions, you are welcome to post them in the Q&A on the brand new website!

Fortis (TSE:FTS)

As you probably know, we’re huge fans of Fortis due to the overall structure of the business. The company generates 99% of its earnings from regulated utilities, and over 93% of the company’s earnings are driven by the transmission and distribution of natural gas and electricity.

When you have a company that generates 99% of its earnings from services that are about the last thing Canadians will go without, it creates stable and predictable cash flows.

This is where we’ll look first, at the company’s investor day presentation in relation to the dividend.

The dividend

With the company raising the dividend in the fourth quarter of 2023, Fortis is at 50 years of consecutive dividend growth, officially making it a Dividend King. Only Fortis and Canadian Utilities have this title in Canada.

It was a foregone conclusion that Fortis was going to raise the dividend. What we want to look at instead is the amount of growth, as it could indicate where the company thinks things will head in the future.

With the consistent cash flows we’ve spoken about, the company can maintain thorough guidance. Regarding the dividend, it expects to be able to raise it by 4%-6% annually through 2028.

This year’s raise comes in at the bottom end of this guidance (4.4%). Is this concerning? It could be, but it depends on how you look at it.

The raise on the lower end of guidance likely means the company does expect some headwinds in the current high-rate environment. However, there are virtually no indications that this dividend is at any risk of being cut or dividend growth stalling, and this could simply be Fortis being prudent.

Not only is Fortis confident they can deliver dividend growth in this range for the next five years, but they’ve also ramped up their capital expenditure plan, investing more money into growth projects despite significantly higher interest rates.

It can do this due to its low exposure to floating-rate debt. The company states that under 5% of its overall debt profile is exposed to variable interest rates. This is the complete opposite of a company like Algonquin Power, which had 22%~ of its debt exposed to floating rate, ultimately causing a lot of issues and a dividend cut.

Overall, the company should be able to provide mid-single-digit dividend growth while offering an attractive yield for income investors for the foreseeable future. Unless something materially changes, there is zero evidence of any stress on the company regarding the dividend.

Fortis’s capital plan

To drive strong dividend growth, the company must drive strong earnings growth. And it expects to do this over the next half-decade, expanding its capital expenditure program despite rising rates.

The company now expects to spend over $25B through to 2028 on investments in the business, which is a $2.7B increase over its capital plan guidance in 2022. They expect the funding and organic growth of the company’s assets will deliver a 6.3% annual rate base growth through to 2028.

Rate base is a complex element of utility companies and is often quite confusing. To explain further, it is the total cost of a utility’s assets required to deliver a service. In Fortis’s case, power for the customers. From there, the municipality can determine how much over and above your rate base you can charge consumers. This would be a utility’s profit. The higher their rate base, the higher their profits.

The highest level of rate base growth is expected to come from ITC, a company in which Fortis owns an 80% stake. It is a U.S.-based electricity transmission company, one of the largest in the country. Strong results in this segment of the business should no doubt be a large portion of the company’s growth.

As such, this is also where the company will spend a large chunk of its capital allocation plans.

Not only will it be looking to modernize the current grid ITC operates on, but it will also look to integrate renewables into the fold, with the expectation that 7,000 megawatts of renewables will be brought onto the system.

Our take

Overall, it would likely bore you if we went through the entire investor presentation. Utilities are boring businesses that generate predictable, reliable cash flows. If debt profiles are solid and capital is being spent wisely, we can often sit back, relax, and enjoy strong returns while we focus on more volatile stocks inside of our portfolio to keep an eye on.

Fortis is no different. Although nothing is ever guaranteed in investing, there were no obvious warning signs in the investor day presentation that would lead us to believe the company will not be able to hit its earnings guidance, dividend guidance, and overall growth objectives.

Fortis, along with Brookfield below, will likely remain at depressed valuations while rates remain high. In our opinion, it’s a perfect time to accumulate.

Brookfield Renewables (TSE:BEP.UN)

Regarding Foundational Stocks, Brookfield Renewable Partners is among the more volatile. It operates in a capital-intensive industry that is still in its infancy. Brookfield’s investor day, which occurred this past week, re-iterated our long-term view of the company. We believe that the transition to renewables will continue and that Brookfield Renewables remains best in class.

That said, let us look at some of the key takeaways from their investor day.

Much like Fortis, Brookfield committed more capital to business growth despite higher rates

Brookfield is not letting higher rates slow them down. Companies with high capital expenditure needs (CAPEX) have had a rough go in recent years. This is because they rely on debt to fund this CAPEX, and with interest rates on the rise, it is becoming more expensive.

That doesn’t seem to bother Brookfield, as it raised CAPEX guidance. The company’s 5-year capital deployment target rose to $7-8B (~$1.5B per year), up from the $6-7B it announced last year. Despite the higher CAPEX and the current high-rate environment, Brookfield’s return on invested capital (ROIC) target remained at 12-15%.

Speaking of interest rates and their impacts, 98% of Brookfield’s debt is fixed, and it has no “material near term maturities.” Brookfield’s approach to projects is to ensure costs and purchase price agreements (PPAs) are all set before construction begins. As a result, the company’s near-term development pipeline (which currently accounts for ~18GW) is de-risked to an extent as the economics are secured.

This means that the company has clear insight into expected costs, which is why we remain confident in the company’s ability to reach ROIC and Funds From Operations (FFO) targets.

The company’s development pipeline has jumped a massive ~80% year-over-year, totalling 135GW. As mentioned, ~18GW of that is considered ‘near-term’ and expected to be commissioned over the next three years. It expects to reach a 7GW run-rate deployment by 2024, a 60% increase YoY.

Despite rising rates, we’re impressed with the company’s growth

Let’s switch focus to FFO, which is a key measure of success for the company. We remain impressed that the company has maintained its 10%+ FFO per unit annual target despite a challenging environment.

This matches the company’s performance over the past decade. Over the last 12 months, the company commissioned a record ~3.4 gigawatts of generation that led to a net annualized increase to FFO of $50M.

Management expects to achieve this through organic growth (7-12%) and M&A (over 9%). The latter had a slight revision upwards, as previous guidance called for “up to 9%.” It’s not a material difference, but the wording does matter.

Since the FFO per unit target didn’t change, neither did the company’s targeted distribution growth rate. The company expects 5-9% annual distribution growth over the next five years.

Finally, we’d be remiss if we didn’t point out that Brookfield’s purchase price agreements and, subsequently, FFO are indexed to inflation. As per its presentation, every 1% increase in inflation results in ~$30M of FFO.

Four key tailwinds we see that should drive strong growth for Brookfield

1. Decarbonization Objectives: Management is seeing accelerated global trends and net zero targets

2. Low-Cost Energy: Bulk electricity is a low-cost option, and 90% of BEP’s pipeline is in the most cost-competitive renewable technology

3. Growing electricity demand: Interestingly, management noted that it experienced a recent spike from customers venturing into AI

4. Energy Security: There is an increased global emphasis on energy independence. This is not surprising, given the conflicts we are seeing worldwide.

Often overlooked, one of Brookfield’s key competitive advantages is access to “diverse sources of capital at scale.” This is a direct result of the company’s relationship with the Brookfield suite of companies.

Access to capital is vital in being able to scale the business. Without it, companies could be forced to delay projects and accept higher rates, both of which would have the net effect of reducing returns.

While it has always been a position of strength, it is even more so today since access to capital is a challenge for many in this environment.

To close, management is “as confident as ever” that it can leverage its access to capital and continue to achieve 12-15% ROIC. Such confidence is a rarity in this environment – especially among those with high CAPEX needs. Similarly, we remain confident that Brookfield Renewables is best-in-class among TSX-listed renewables.

That is not to say the company will not be subject to continued volatility. Despite all the positives from their investor day, it remains a challenging operating environment for renewables. However, if one takes the long-term view, we see Brookfield as an industry leader. Over time, that will likely lead to outperformance.