Hot Hydro One stock hits new highs

Hydro One (TSX:H) has been electrifying investors with its performance this year – pardon the pun.

But the big question is whether the rally, which began several years ago, has outrun the utility’s fundamentals. Many analysts think so, but investors continue to push the shares higher.

At the current price of $49.16 Hydro One stock is up 11% year-to-date. The shares are 22% higher in the past 12 months. That’s pretty good. We are talking about a sleepy, regulated utility, not an AI startup.

Hydro One provides a vital, but not very exciting, service, moving and distributing 98% of Ontario’s electricity.  Its revenues and profits are fairly predictable. The province owns 47% of the common shares.

So what’s up?

Hydro One is in the enviable position of being able to withstand a downturn at a time of high uncertainty while delivering a good dividend in that climate. As cooler heads have prevailed in trade negotiations with the US, Ontario Premier Doug Ford’s unhelpful threat to impose tariffs on electricity exports has faded. That’s another lift. As is the fact that it is a clean energy utility. It does not generate electricity, just moves it.

As with most energy utilities Hydro One has a limited exposure to tariffs. Whatever rising costs it faces can be passed on to its customers. A recession would reduce energy demand and hurt earnings, but it is unlikely to lead to a dividend cut. Its dividend actually becomes more attractive in this environment, because interest rates tend to fall in recessions.

Another source of optimism is Hydro One’s performance. First quarter revenue rose 11% to $2.41 billion and earnings per share (EPS) rose 22% to $0.60. The higher revenues resulted from Ontario Energy Board (OEB)-approved transmission and distribution rates, higher monthly peak demand and cost-cutting initiatives.

Yet, while investors have moved into the shares, analysts are cautious. Most see it as fairly valued, or over-priced, based on fundamentals.

As reported by the Globe & Mail, TD Cowen analyst John Mould who recently initiated coverage of Canada’s utility sector, has set a target of $52 for Hydro One and sees it as a hold, rather than buy. Benjamin Butler an analyst at Veritas Research sees it about 10% above its fair value. He sees it as a sell with a $45.50 target. Mr. Butler believes Hydro is best in class but feels the price premium it commands is too high. He notes it trades at a trailing 12 month earnings per share is  26, versus the peer average of 19.  

RBC Capital Markets analyst Maurice Choy said in a recent research note that Hydro One is a  stock of choice for investors seeking defensive exposure in the utilities sector. He says it is a good option given economic volatility and the potential for recession rhetoric. He gives it high marks for a clear and simple strategy but also sees it as fully valued. His target is $53.

Finally, Morningstar analyst Andrew Bischof sees fair value at $43. He expects Hydro One’s dividend to grow and sees  the company maintaining its 70% to 80% dividend payout ratio. He says Hydro One has among the strongest balance sheets in the sector, meaning it can fund its investments internally without borrowing. This lowers its costs. At current levels, he sees is roughly 10%  overpriced.

So investors love the stock, but analysts think its too pricey. They agree it is a top-of-class utility, but that sentiment has carried the share price too far. That doesn’t meant the shares will fall, or that they can’t continue to outperform for a long time yet. The company offers a unique combination of safety, income and modest growth. The dividend may not be best in class, but investors certainly view it as secure.

This article appeared in a recent issue of the Income Investor.  For information on how to reprint this article please view this page.