Patience pays off for Hydro One investors

There was a time, not so long ago, when Hydro One (TSX:H) was in the news for all the wrong reasons.

It was during the 2018 Ontario election when Conservative Party leader Doug Ford latched on to high electricity prices as a populist cause and then drew a straight line from high prices to executives being paid too much. Once elected he cleaned house, firing Hydro One’s board of directors which led to the resignation of its CEO and other members of the executive team. By mid-summer that year Hydro One’s stock was trading at $19, about 24% less than its issue price three years earlier. The big losers? Small investors and the province which owns 47% of Hydro One shares.   

Things got worse from there. As Hydro One looked for a new boss and board, a proposed takeover of a Washington-state utility fell apart. US regulators were turned off by the Ontario government meddling in Hydro’s affairs and said no thanks. That cost Hydro One shareholders a $103 million penalty.

Strange as it may seem, since then only good things have happened for investors in Hydro One. The board and CEO were replaced, the rhetoric disappeared and the storm passed. Hydro One’s shares have doubled since their 2018 swoon at their current price of $37.84.  The company has increased its dividend in each of the last 8 years.

As we move through a year with high political and economic volatility, a utility in our backyard has a lot of appeal. While not recession proof, the business is recession resistant.

It is largely insulated from global events and grows slowly and steadily as  Ontario grows.

 Here’s a closer look:

Background: Hydro One was created from the old Ontario Hydro in 2015. It has two main businesses: the transmission of electricity and the distribution of electricity to utilities throughout the province. Overall, it transmits 98% of Ontario’s electricity and serves 1.5 million customers. The province still owns 47% of the common shares.

Performance:  The shares hit a high of $41.69 in early March but have sold off since by about 7% at the current price of $38.21.  They are down 4% year-to-date.

In its fourth quarter of 2023, Hydro One reported a 6.3% increase in revenue to $1.98 billion helped by rising demand at peak times and higher transmission rates. Earnings per share of $0.30 were flat, but slightly above analysts’ expectations.

Discussion & Outlook:  In a recent research note, Morningstar analyst Andrew Bischof says the political atmosphere has stabilized for Hydro One, reducing the risk of future interference. He sees the company as working well with the Ontario Energy Board which regulates the prices it charges. The OEB “has proved to be a good partner overall,” he said.

While allowed returns are less than in the US, the OEB has approved capital spending plans of $12 billion which provides clarity into the company’s near-term growth. The spending includes investments to improve performance, modernize infrastructure and support increased demand while addressing safety and environmental risks. Mr. Bischof sees earnings rising by 5-to-7% annually.

 He sees Hydro One buying smaller provincial utilities as the opportunity arises, but concludes the biggest risk for investors is shifting political winds. AS well, should interest rates rise and not fall, Hydro’s costs would go up and its dividend would be less attractive than other options.

 RBC Capital markets analyst Maurice Choy believes Hydro One is well-positioned “as a stock of choice for investors seeking defensive exposure” in the utilities sector. He says it  is a good option amidst volatility and ongoing recession rhetoric.

Mr. Choy likes the simplicity of its business which includes a good environmental, social and governance (ESG) score because its assets are towers and wires not power generation. He has a $41 price target.

Dividend: The $1.19annual dividend yields 3.1% at  current prices. Mr. Choy sees it growing by 5.5% this year and another 5% in 2025.

Conclusion: Hydro One offers slow, steady growth and a dividend that has been rising. It is insulated from commodity prices changes since it transmits electricity but does not generate it. It is likewise insulated from global political and economic disorder with a product needed at all times.

Its biggest risk is that the province has an outsized influence on the company through its ownership and regulation via  the Ontario Energy Board. For now, it is all quiet on both fronts, but as always that could change.

This article appeared in the Income Investor on Apr. 25, 2024.  For information on how to reprint this article please view this page.