Strengthen Your Portfolio With These High-Yield Canadian Stocks
Utilities have been one of the top-performing sectors this year, outdistancing the S&P 500 with total returns of better than 13% versus just 6% for the benchmark index.
Canadian utilities stocks have also trumped the U.S. equity index with robust 8% returns. As central banks in both Canada and the United States have kept interest rates at historic lows, risk-averse income investors have moved into safe dividend stocks like utilities in lieu of bonds.
#-ad_banner-#Despite the gains, Canadian utilities, as represented in the S&P/TSX Capped Utilities Index, still offer an attractive 4.4% average yield — compared with just 3.8% for their U.S. peers and 1.8% for the S&P 500.
As interest rates normalize, bonds could compete with yield plays and also raise the cost of capital for utilities. But central banks rates are expected to raise rates slowly over the next 12 months, by only 50 basis points in Canada and 75 basis points in the United States, according to Bloomberg consensus estimates. Meanwhile, utility stocks should continue to benefit from low interest rates for the foreseeable future.
Canadian utilities operate much like those in the United States. As in the Unites States, the rates charged for transmitting and distributing electricity are generally regulated. The price for producing electricity is also still generally set by regulators in all provinces, except for Alberta and Ontario.
A diversified utility, like Nova Scotia-based Emera, Inc. (TSX: EMA), generates as much as 80% of earnings from rate-regulated activities. However, long-term 20-year contracts, called Power Purchase Agreements, also provide predictable cash flow to non-regulated power producers like Ontario-based Algonquin Power & Utilities Corp. (TSX: AQN) and Alberta-based TransAlta Renewables (TSX: RNW). Rate-regulated or contracted utilities like these grow by expanding the rate base or developing new projects.
At the other end of the spectrum are independent power producers like Northland Power (TSX: NPI), Atlantic Power (TSX: ATP), Capital Power (TSX: CPX) and Capstone Infrastructure (TSX: CSE) that are positioned to benefit from rising spot-market power prices. Alberta-based Capital Power, for example, has seen power prices in oil-rich Alberta nearly double to C$80/megawatt hours (MWh) in 2013 from C$48/MWh in 2009.
Although operating in Canada, many Canadian utilities also generate much of their revenues in the United States, including Algonquin and Emera as well as Bermuda-based Brookfield Renewable (TSX: BEP.UN) and Boston-based Atlantic Power. Both Brookfield Renewable and Atlantic Power are co-listed on the New York Stock Exchange under the tickers BEP and AT. The others trade over-the-counter in the United States.
These eight electric utilities are listed below. While they each operate in different segments of the industry, they all meet certain strict criteria:
— 4% minimum yield (annualizing last quarterly payment)
— 100,000-share minimum daily average trading volume
— 8% minimum year-to-date total returns (including share price and dividends)
— 100% maximum 2013 dividend payout ratio from earnings, funds from operations, or cash available for distribution
Each of these utilities has a unique growth story, but we are especially attracted to Algonquin for its balanced mix of regulated and non-regulated revenue streams.
Algonquin (OTC: AQUNF; TSX: AQN) operates mainly in the United States through two subsidiaries. Liberty Utilities is a regulated utility that distributes water, electricity, and gas to some 500,000 customers in 10 U.S. states. Algonquin Power Company is a producer that owns or has interests in around 40 hydroelectric, wind and solar power facilities in Canada and the United States.
2013 was a transformative year for Algonquin thanks to some significant acquisitions, which expanded the asset base by 25% and grew annual revenues by 94% over 2012. Earnings before extraordinary items more than doubled, and adjusted per-share earnings grew 146% to C$0.27 from C$0.11. The company attributed its growth mainly to acquisitions completed in 2012 and 2013.
The acquisitions added 135,000 utility customers, which together with rate increase requests totaling over $29 million should accrete to earnings. Analysts expect adjusted per-share earnings to grow a robust 26% this year to C$0.34, and the momentum is forecast to continue with a further 15% growth to C$0.39 in 2015.
Risks to Consider: Canadian/U.S. currency fluctuations may affect cash flows. About 70% of cash flow from operations is generated in U.S. dollars. Management estimates that, on an unhedged basis, a $0.10 increase in the strength of the U.S. dollar relative to the Canadian dollar would result in a net impact on U.S. operations of approximately $16.2 million ($0.08 per share) annually. The company manages this risk primarily through the use of hedges, using U.S. long-term debt to finance its U.S. operations. The company does not use derivatives for trading or speculative purposes.
Action to Take –> Algonquin has a diversified revenue stream, both geographically and operationally, and a balanced mix of regulated and non-regulated businesses. A strong track record of delivering 11% dividend growth and 18% shareholder returns annually for the past three years bodes well for investors. If you’re seeking a steadily rising income stream supported by predictable revenues, this utility is worth a look.
Each month StreetAuthority’s premium newsletter High-Yield International highlights some of the best Canadian investments, like Algonquin, in a column called Northern Lights. However, Canadian investments are just a fraction of the most lucrative international stocks available. In fact, if you’re ignoring overseas markets, then you could be missing out on some of the market’s biggest income opportunities. All told, we’ve found 93 companies paying 12%-plus yields — and nearly a thousand more paying above 6%. For more information about High-Yield International and to get access to issues of Northern Lights (like the excerpt above), click here.
The investing ideas presented in this column are meant to serve as a good starting point for further research. Some securities may prove to be better investments than others. Please do your own due diligence to decide if a security matches your investment needs.