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In Through the Out Door

This year’s fear trade has been frustrating. While we’ve certainly enjoyed watching our high-quality dividend stocks head higher, rising values have left few bargains.

But dividend stocks such as utilities finally got ahead of themselves, and now we’re approaching the inevitable correction.

Although share-price declines can be unnerving, we believe that a near-term correction is actually healthy for dividend stocks, especially utilities.

It can also afford a buying opportunity.

To that end, we periodically run a screen to see if some of our favorite utilities are approaching a compelling valuation, or at least a more reasonable price.

Right now, the Canada-based utility holding company Emera Inc. (TSX: EMA, OTC: EMRAF) has one of the lowest price-to-earnings ratios (P/E) among utilities that derive most of their earnings from regulated operations.

The utility is noteworthy for being one of the handful of Canadian companies that have recently made cross-border deals with hopes of boosting growth to offset a weak economy in the Great White North. Emera’s $10.4 billion acquisition of Florida-based TECO Energy closed on July 1.

The deal should prove to be transformative for the Canadian acquirer. Emera now derives the vast majority of its earnings from the faster-growing U.S. (currently around 71% of earnings vs. 40% prior to the deal), which puts it on a stronger earnings-growth trajectory, of around 8% annually through 2019.

In its U.S. segment, Emera has operating subsidiaries in New England, Florida and New Mexico. The firm also has a Caribbean segment (4% of earnings), in addition, of course, to its domestic operations, most of which are situated in Canada’s Maritime provinces (25% of earnings).

Equally important, the deal also increases Emera’s regulated earnings to 84% from 72%. While merchant power has given some utilities a growth kicker in the past, it can also cause significant earnings volatility.

In recent years, for instance, wholesale power markets have been depressed. And once energy prices crashed, that forced wholesale power prices even lower.

Consequently, utilities have been shedding unregulated assets and acquiring regulated assets, a trend that’s been one of the major investment themes of the past couple years.

Robust earnings growth should also flow through to the dividend, which has grown by 8.4% annually over the past five years, for a forward yield of 4.5%.

One concern is that the TECO deal was a sizable one for Emera, and leverage has risen accordingly, to around 5.1 times net debt to EBITDA (earnings before interest, taxation, depreciation and amortization).

But that should decline as TECO’s earnings start going to Emera’s bottom line. The company has investment-grade credit ratings from both Moody’s (Baa3 with a “stable” outlook) and Standard & Poor’s (BBB+ with a “negative” outlook). The S&P rating is two notches above Moody’s, hence its negative outlook compared to Moody’s stable outlook.

For its part, while Moody’s acknowledges Emera’s high consolidated leverage, the credit rater notes that Emera will now have a lower risk profile thanks to the increase in regulated earnings and greater geographic diversification. And Moody’s expects leverage will decline to a more comfortable level over the next three years.

Analysts are largely bullish on the stock, with seven “buys,” four “holds,” and one “sell.” The consensus 12-month target price is US$40.98, which suggests potential appreciation of 15.4% above the current share price.

In addition to its attractive valuation and dividend growth, Emera also offers value-conscious U.S. income investors another enticement. The decline in the Canadian dollar, recently just below US$0.76, affords an opportunity to buy into a mostly U.S. company at a nearly 25% discount.


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