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FTS

Fortis Inc

December 24, 2024
| **ACCUMULATE** on weakness |
A
Investment Thesis

Fortis Inc is a North American regulated utility holding company with an exceptional 51-year dividend growth streak, operating ~99% regulated assets across Canada, the US, and the Caribbean. The company offers defensive characteristics (Beta 0.40) with visible 6.5% annual rate ba...

Key Risk

ROE compression, regulatory lag

(3 sentences):**

21.22x P/E
5% ROE
OppRiskFinMoatMgmtCat 5/6

EXECUTIVE SUMMARY

Investment Thesis (3 Sentences)

Fortis Inc is a North American regulated utility holding company with an exceptional 51-year dividend growth streak, operating ~99% regulated assets across Canada, the US, and the Caribbean. The company offers defensive characteristics (Beta 0.40) with visible 6.5% annual rate base growth supported by a $26 billion 5-year capital plan targeting grid modernization and clean energy transition. While ROE (7.61%) is below Buffett's 15% threshold, this is typical for regulated utilities that trade lower returns for stable, predictable cash flows secured by regulatory compact.

Key Metrics Dashboard

Metric Value Assessment
Market Cap $26.2B USD Large-cap utility
P/E (TTM) 21.22 Premium valuation
Forward P/E 19.57 Moderate
P/B Ratio 1.58 Fair
ROE (TTM) 7.61% Below 15% (utility typical)
Dividend Yield 4.8% Attractive
Dividend Growth 51 years Exceptional
Beta 0.40 Low volatility
Debt/Equity 1.40 Elevated (utility typical)

Recommendation Summary

Component Assessment
Quality Score 85/100 - High quality regulated utility
Moat Durability WIDE - Government-granted monopoly
Risk Score LOW - Regulatory compact protects returns
Catalyst Visible: $26B CapEx, 6.5% rate base CAGR
Verdict ACCUMULATE on weakness

PRE-ANALYSIS SCREENING

Step 1: Immediate Disqualifiers (Munger Anti-Checklist)

Disqualifier Status Notes
Outside circle of competence PASS Regulated utility - simple business model
Heavily promoted by Wall Street PASS Low coverage, boring utility
Requires macro forecast PASS Rate base growth secured by regulation
Questionable management PASS Long tenure, aligned with shareholders
Complex capital structure PASS Simple common equity, no preferred
Single customer dependence PASS 3.4 million customers diversified
Requires technology prediction PASS Traditional utility infrastructure
Sharp price drop bias PASS Researching for portfolio fit, not reaction
Social proof trap PASS Not widely owned by famous investors
Story > numbers PASS Numbers drive thesis
Can't identify opportunity PASS Utility sector out of favor post-rate hikes

Result: PASSES all anti-checklist items

Step 2: Graham's 7 Criteria for Defensive Investors

# Criterion Test FTS Status Pass?
1 Adequate Size Assets > $50M (utility) $73.5B assets PASS
2 Strong Financial Condition Current Ratio > 2:1 ~0.6:1 (utility typical) FAIL
3 Earnings Stability Positive 10 years 10+ years profitable PASS
4 Dividend Record 20+ years uninterrupted 51 consecutive years PASS
5 Earnings Growth >33% EPS growth 10 years ~50%+ (5-yr CAGR 7.1%) PASS
6 Moderate P/E P/E < 15 (3-yr avg) P/E 21.22 FAIL
7 Moderate P/B P/B < 1.5 or P/E×P/B < 22.5 P/E×P/B = 33.5 FAIL

Graham Number Calculation:

Graham Number = √(22.5 × EPS × BVPS)
Where: EPS = $2.44 (TTM), BVPS = $27.40 (approx)
Graham Number = √(22.5 × 2.44 × 27.40) = √$1,504 = $38.78

Result: FAILS Graham defensive criteria (typical for quality utilities which trade at premiums)

Step 2b: Buffett Quality Criteria

Criterion Status Notes
One-sentence business PASS "Fortis owns regulated electric and gas utilities that earn allowed returns on invested capital"
ROE > 15%? FAIL 7.61% (but typical for regulated utilities)
Management skin in game PASS Long-tenured executive team with equity comp
Identifiable moat PASS Government-granted monopoly
Consistent FCF PARTIAL OCF strong, FCF negative due to growth CapEx

Step 3: Megatrend Resilience Screen

Megatrend Score Notes
China Tech Superiority +1 Immune - domestic infrastructure
Europe Degrowth +1 Immune - North American focus
American Protectionism +2 Benefits - domestic energy infrastructure spending
AI/Automation +2 Benefits - data center load growth driving demand
Demographics/Aging +1 Immune - essential utility services
Fiscal Crisis 0 Neutral - regulated rates may lag inflation
Energy Transition +2 Benefits - $7B clean energy CapEx, grid modernization

Total Score: +9 | Tier: 1 "Fortress"

All scores ≥ 0 and total ≥ +7 qualifies for Tier 1 full position sizing

Step 4: Macro Debt Cycle Assessment

Canada Debt Position:

Indicator Value Status
Total Debt/GDP ~105% OK
Debt growth (3yr) ~10% of GDP OK
Household debt Elevated Caution
Short rates 3.25% (falling) Normalizing

Debt Cycle Stage: Late deleveraging / Early normalization

Company Macro Resilience:

  • Debt in own currency (CAD/USD)
  • Counter-cyclical demand (essential utility)
  • Strong OCF regardless of credit conditions
  • Pricing power through regulation
  • Net cash position (elevated debt, but appropriate for utility)

Macro Resilience Score: Green Flags: 4 | Red Flags: 0


PHASE 1: RISK ANALYSIS (Inversion Thinking)

"All I want to know is where I'm going to die, so I'll never go there." - Munger

1.1 Technological Disruption Risk

Risk Factor Probability Impact Expected Loss
Rooftop solar/DER disruption 15% 20% value loss 3%
Battery storage bypass 10% 15% value loss 1.5%
Grid defection 5% 30% value loss 1.5%

Analysis:

  • Fortis owns transmission (ITC) and distribution networks - even with distributed generation, the grid remains essential
  • Data center boom requires massive grid interconnection (bullish for transmission)
  • Regulated utility model allows recovery of stranded costs in most jurisdictions

Mitigation: Rate base includes grid modernization investments that adapt to new technologies.

1.2 Regulatory/Legal Risk

Risk Factor Probability Impact Expected Loss
ROE compression (secular) 60% 5% value loss 3%
Iowa ROFR adverse ruling 30% 3% value loss 0.9%
BC policy uncertainty 20% 2% value loss 0.4%
Arizona wildfire liability 10% 10% value loss 1%

Key Regulatory Risks:

  1. FERC ROE Compression: MISO base ROE reduced to 9.98% in 2024; ITC all-in ROE at 10.73% with incentives
  2. Iowa ROFR Litigation: District court ruled against ROFR; Iowa Supreme Court granted stay; ~70% of projects are upgrades on existing rights-of-way
  3. S&P Climate Risk Concerns: Negative outlook citing physical/climate risks; FFO/debt threshold raised to 12%

Mitigation: Multi-jurisdictional diversification limits regulatory concentration risk.

1.3 Financial/Operational Risk

Risk Factor Probability Impact Expected Loss
Cost overruns on $26B plan 40% 3% value loss 1.2%
Interest rate spike impact 20% 8% value loss 1.6%
Execution risk on growth 25% 5% value loss 1.25%

Analysis:

  • Eagle Mountain Gas Line project increased from $420M to $750M (79% increase)
  • High leverage (D/E 1.40) means interest rate sensitivity
  • Strong OCF (212% of net income) provides buffer

1.4 Climate/ESG Risk

Risk Factor Probability Impact Expected Loss
Wildfire liability (Arizona) 10% 15% value loss 1.5%
Stranded fossil assets 15% 5% value loss 0.75%
Carbon transition costs 50% 3% value loss 1.5%

Emissions Targets:

  • 33% reduction achieved vs 2019
  • 50% by 2030, 75% by 2035, Net zero by 2050
  • TEP coal closure: remaining 900 MW by 2032

INVERSION SECTION (Required)

How could this investment lose 50%+ permanently?

  1. Sustained high inflation causes rate lag → earnings erosion → dividend cut → yield-driven selling
  2. Major wildfire liability in Arizona (low probability given asset locations)
  3. Complete loss of MISO transmission opportunities + adverse ROFR ruling
  4. Nationalization or major regulatory restructuring (extremely low probability)

What would make me sell immediately (non-price triggers)?

  1. Dividend cut or freeze (breaks 51-year streak)
  2. Management integrity issues or governance failures
  3. Major unrecoverable disaster (wildfire, nuclear incident at utility peer causing regulatory contagion)
  4. Credit downgrade to junk status

Bear Case (3 sentences): Fortis trades at a 21x P/E premium despite earning only 7.6% ROE - a valuation that requires perpetual growth in a regulated industry facing secular ROE compression. The $26 billion capital plan relies on regulatory approvals and rate recovery that may face pushback from cost-conscious commissions. Data center load growth excitement ignores the capital intensity of serving this demand and potential for overbuild.

Can I state the bear case better than the bears? Yes - but the regulatory compact provides strong downside protection, and the dividend streak demonstrates management's commitment to shareholders.


PHASE 2: FINANCIAL ANALYSIS

2.1 Profitability Metrics

5-Year Financial Trend (USD millions):

Year Revenue Operating Income Net Income ROE
2024 $11,508 $3,292 $1,680 7.6%
2023 $11,517 $3,084 $1,573 7.5%
2022 $11,043 $2,740 $1,394 6.8%
2021 $9,448 $2,469 $1,294 6.9%
2020 $8,935 $2,508 $1,274 7.0%

5-Year CAGR:

  • Revenue: 6.5%
  • Operating Income: 7.0%
  • Net Income: 7.1%
  • EBITDA: 7.7%

DuPont ROE Decomposition:

ROE = Net Margin × Asset Turnover × Equity Multiplier
ROE = 14.6% × 0.156 × 3.09 = 7.0%

Where:
- Net Margin: $1,680M / $11,508M = 14.6%
- Asset Turnover: $11,508M / $73,486M = 0.156
- Equity Multiplier: $73,486M / $23,808M = 3.09

Key Insight: Low ROE is driven by low asset turnover (capital-intensive utility) and moderate leverage, not poor margins. This is structural for regulated utilities.

2.2 Owner Earnings Calculation

Owner Earnings = Net Income + D&A - Maintenance CapEx

Net Income (2024):                    $1,680M
+ Depreciation/Amortization:          ~$2,200M (estimated from EBITDA-EBIT)
- Maintenance CapEx:                  ~$1,500M (estimated 30% of total CapEx)
= Owner Earnings:                     ~$2,380M

Owner Earnings per Share = $2,380M / 505M shares = ~$4.71/share

2.3 Valuation Analysis

Valuation Method Summary:

Method Value/Share Current Price Margin of Safety
Graham Number $38.78 $43 USD -11% (overvalued)
Owner Earnings (10x) $47.10 $43 USD +9%
Owner Earnings (15x) $70.65 $43 USD +39%
DCF (Conservative) $48-52 $43 USD +12-21%
Peer Multiple $45-50 $43 USD +5-16%

DCF Assumptions (Conservative):

  • Growth rate: 5% (below 6.5% rate base growth guidance)
  • Terminal growth: 2%
  • Discount rate: 8%
  • Terminal multiple: 12x EBITDA

Relative Valuation:

Peer P/E Dividend Yield ROE
Fortis (FTS) 21.2x 4.8% 7.6%
Emera (EMA) 18.5x 5.2% 7.2%
Canadian Utilities (CU) 17.0x 5.4% 8.1%
Duke Energy (DUK) 19.5x 3.8% 9.5%
Southern Company (SO) 20.0x 3.5% 12.8%

Fortis trades at a premium to Canadian peers but in-line with US peers, reflecting its larger US operations and superior dividend growth track record.

2.4 Cash Flow Analysis

Year Operating CF CapEx Free Cash Flow Dividends
2024 $3,882M $5,218M ($1,336M) $818M
2023 $3,545M $4,169M ($624M) $768M
2022 $3,074M $3,865M ($791M) $737M
2021 $2,907M $3,386M ($479M) $671M
2020 $2,701M $4,039M ($1,338M) $851M

Key Observations:

  1. Negative FCF is structural - growth-mode utility funding $26B capital plan
  2. OCF covers dividends easily - 21-24% payout ratio on OCF basis
  3. OCF/Net Income > 200% - strong cash conversion due to depreciation
  4. Funding Gap: Bridged through debt issuance and DRIP (dividend reinvestment)

PHASE 3: MOAT ANALYSIS

3.1 Moat Sources Identified

Moat Type Strength Durability Evidence
Government-Granted Monopoly WIDE 30+ years ~99% regulated assets; exclusive service territories
Regulatory Compact WIDE 20+ years Allowed ROE on rate base; cost-plus model
Scale Advantages MEDIUM 15+ years $53B rate base by 2029; largest regulated utility in Canada
Switching Costs HIGH Indefinite Customers cannot choose alternative provider

3.2 Moat Metrics

Pricing Power:

  • TEP ROE: 9.75% allowed
  • UNS Electric ROE: 9.75% allowed
  • Central Hudson ROE: 9.5% allowed (improved from 9.0%)
  • ITC ROE: 10.73% all-in with incentives

Customer Retention: ~100% (regulated monopoly)

Market Share Stability: 100% in service territories

ROIC vs WACC:

  • Estimated ROIC: ~5.5% (on total capital)
  • Estimated WACC: ~6.0%
  • Spread: ~-0.5% (but allowed ROE on equity > cost of equity)

3.3 Moat Durability Assessment

Forces of Erosion:

Threat Severity (1-5) Timeline Company Mitigation
Distributed generation 2 10-20 years Grid still essential; transmission investments
ROE compression 3 Ongoing Multi-jurisdictional diversification
Political/regulatory change 2 Variable Constructive regulatory relationships
Technology bypass 1 20+ years Grid infrastructure remains critical
Climate liability 2 5-15 years Risk mitigation programs; favorable jurisdictions

10-Year Moat Trajectory: STABLE to WIDER

  • Grid modernization increases asset criticality
  • Data center/electrification drives transmission investment
  • Regulatory compact remains intact in democratic societies

PHASE 4: MANAGEMENT & INCENTIVE ANALYSIS

4.1 Leadership Team

Executive Role Tenure Assessment
David Hutchens President & CEO 5+ years Strong operational background
Jocelyn Perry EVP & CFO 10+ years Disciplined capital allocation

4.2 Capital Allocation Track Record

Use of FCF Allocation Quality Assessment
CapEx (Rate Base Growth) ~65% Strong - regulated returns
Dividends ~20% Strong - 51 years of growth
Debt Service ~15% Neutral - managing leverage

Key Capital Decisions (Last 5 Years):

  • ✅ ITC Acquisition (2016) - High-quality transmission assets
  • ✅ $26B capital plan focused on regulated investments
  • ⚠️ Eagle Mountain cost escalation ($420M → $750M)
  • ✅ Sold non-regulated Aitken Creek storage facility

4.3 Insider Activity

Low insider ownership (0.25%) is typical for large utilities. No significant insider sales reported.

4.4 Incentive Alignment

  • Compensation tied to rate base growth, EPS growth, TSR
  • Long-term incentive plans with 3-year vesting
  • Dividend growth commitment suggests shareholder alignment

PHASE 5: CATALYST ANALYSIS

5.1 Identified Catalysts

Catalyst Type Timeline Probability Impact
MISO Tranche 2.1 approval External H2 2024-2025 80% +5%
Arizona data center contracts Operational 2025-2027 60% +3%
Iowa ROFR resolution Legal 2025 70% +2%
Rate case outcomes (Central Hudson, TEP) Regulatory 2025 75% +2%
Interest rate normalization External 2025-2026 70% +5%

5.2 Upside Opportunities

  • MISO Tranche 2.1: $21.8B portfolio; ITC portion estimated at $3B+
  • Arizona Load Growth: TEP/UNS seeing significant data center interest; $2.5-5B incremental investment opportunity
  • Big Cedar Data Center: $400M investment for 1,600 MW data center load
  • Rate Relief: Formula rates or forward test years would reduce Arizona regulatory lag

5.3 No-Catalyst Assessment

Even without catalysts, Fortis offers:

  • 4.8% current yield
  • 4-6% dividend growth (through 2029 guidance)
  • 6.5% rate base CAGR visibility
  • Total expected return: 9-11% annually

PHASE 6: DECISION SYNTHESIS

6.1 Quality Score

Component Weight Score Weighted
Business Quality 25% 90 22.5
Moat Durability 25% 85 21.25
Financial Strength 20% 75 15.0
Management Quality 15% 80 12.0
Growth Visibility 15% 85 12.75
Total 100% 83.5

6.2 Risk Score

Risk Category Weight Score (1-10) Weighted
Regulatory Risk 30% 3 0.9
Financial Risk 25% 4 1.0
Operational Risk 20% 2 0.4
Competitive Risk 15% 1 0.15
Macro Risk 10% 3 0.3
Total 100% 2.75 (Low)

6.3 Expected Return Probability Tree

Scenario Probability 5-Year Total Return Weighted Return
Bull Case 20% +80% +16%
Base Case 55% +50% +27.5%
Bear Case 20% +15% +3%
Disaster 5% -30% -1.5%
Expected 100% +45%

Annualized expected return: ~7.8% (excludes dividends) + 4.8% yield = ~12.6% total

6.4 Position Sizing

Position Size = Base × (MOS/Target) × (Quality/100) × (1-Risk) × Catalyst Mult.

Where:
- Base: 4% (Tier 1 "Fortress" allocation)
- MOS: 15% / Target 20% = 0.75
- Quality: 83.5/100 = 0.835
- Risk: 1 - 0.275 = 0.725
- Catalyst: 1.0 (catalysts present)

Position Size = 4% × 0.75 × 0.835 × 0.725 × 1.0 = 1.8%

Recommended Position: 2% at current prices; increase to 4% at Buffett Buy Price


INVESTMENT RECOMMENDATION

┌─────────────────────────────────────────────────────────────────┐
│                     INVESTMENT RECOMMENDATION                    │
├─────────────────────────────────────────────────────────────────┤
│ Company: Fortis Inc            Ticker: FTS (TSX/NYSE)           │
│ Current Price: CAD $61 / USD $43    Date: December 24, 2024     │
├─────────────────────────────────────────────────────────────────┤
│ VALUATION SUMMARY                                                │
│ ┌─────────────────────────┬─────────────┬─────────────────────┐ │
│ │ Method                  │ Value/Share │ vs Current Price    │ │
│ ├─────────────────────────┼─────────────┼─────────────────────┤ │
│ │ Graham Number           │ USD $38.78  │ -10% (overvalued)   │ │
│ │ Owner Earnings (10x)    │ USD $47.10  │ +10%                │ │
│ │ Owner Earnings (15x)    │ USD $70.65  │ +64%                │ │
│ │ DCF (Conservative)      │ USD $50.00  │ +16%                │ │
│ │ Peer Median             │ USD $45.00  │ +5%                 │ │
│ └─────────────────────────┴─────────────┴─────────────────────┘ │
│                                                                  │
│ INTRINSIC VALUE ESTIMATE: USD $48 / CAD $67 (weighted average)  │
│ MARGIN OF SAFETY: 12%                                            │
├─────────────────────────────────────────────────────────────────┤
│ RECOMMENDATION:  [ ] BUY  [X] WAIT/ACCUMULATE  [ ] HOLD [ ] SELL│
├─────────────────────────────────────────────────────────────────┤
│ BUY PRICE (Strong Buy):     CAD $47 / USD $34 (30% below IV)    │
│ ACCUMULATE PRICE:           CAD $54 / USD $38 (20% below IV)    │
│ FAIR VALUE:                 CAD $67 / USD $48                   │
│ TAKE PROFITS PRICE:         CAD $80 / USD $58 (20% above IV)    │
│ SELL PRICE:                 CAD $100 / USD $72 (50% above IV)   │
├─────────────────────────────────────────────────────────────────┤
│ POSITION SIZE: 2% starter now; 4% at Strong Buy Price           │
│ CATALYST: MISO Tranche 2.1, data center load, rate cuts         │
│ PRIMARY RISK: ROE compression, regulatory lag                   │
│ SELL TRIGGER: Dividend cut, credit downgrade to junk            │
└─────────────────────────────────────────────────────────────────┘

Recommendation Rationale

WAIT/ACCUMULATE - Fortis is a high-quality, Tier 1 "Fortress" utility with an exceptional 51-year dividend growth streak and visible growth catalysts. However, the current price offers only ~12% margin of safety, which is below the 20% minimum threshold for initiating a full position.

Action Plan:

  1. At current price (CAD $61): Small starter position (1-2%) acceptable for portfolio diversification
  2. At CAD $54 / USD $38: Accumulate to 3% position
  3. At CAD $47 / USD $34: Full 4-5% position (Tier 1 allocation)

Explicit Sell Triggers

  1. Thesis Break: Dividend cut or freeze (ends 51-year streak)
  2. Moat Erosion: Sustained ROE compression below 8% across portfolio
  3. Management Failure: Governance scandal, excessive leverage (>2.0 D/E)
  4. Valuation: Price exceeds CAD $100 / USD $72 (50% above fair value)

Monitoring Metrics

Metric Current Threshold Action if Breached
Dividend Growth 4.2% <3% for 2 years Review thesis
FFO/Debt 11.4% <10% Reduce position
Rate Base CAGR 6.5% <4% Review thesis
Allowed ROE (avg) ~10% <8.5% Accept lower returns or exit
S&P Rating BBB+ Below BBB Significant concern

APPENDICES

Appendix A: Source Documents

Document Source Local Path
Annual Report 2024 Fortis IR data/annual-report-2024.pdf
Annual Report 2023 Fortis IR data/annual-report-2023.pdf
Annual Report 2022 Fortis IR data/annual-report-2022.pdf
Income Statement AlphaVantage data/income-statement.json
Balance Sheet AlphaVantage data/balance-sheet.json
Cash Flow AlphaVantage data/cash-flow.json
Company Overview AlphaVantage data/company-overview.json
Earnings Transcript Q3 2024 AlphaVantage data/earnings-transcript-Q3-2024.md
Earnings Transcript Q2 2024 AlphaVantage data/earnings-transcript-Q2-2024.md
Earnings Transcript Q1 2024 AlphaVantage data/earnings-transcript-Q1-2024.md
Earnings Transcript Q4 2023 AlphaVantage data/earnings-transcript-Q4-2023.md
Historical Prices EODHD data/historical-prices.json
Dividend History EODHD data/dividends.csv

Appendix B: Key Assumptions

Assumption Value Confidence Sensitivity
Rate base CAGR 6.5% High ±1% = ±5% IV
Allowed ROE (average) 9.5% Medium ±0.5% = ±8% IV
Dividend growth 5% High ±1% = ±3% IV
Terminal growth 2% Medium ±0.5% = ±10% IV
Discount rate 8% Medium ±0.5% = ±8% IV

Appendix C: Quarterly Dividend History (CAD)

Year Q1 Q2 Q3 Q4 Annual YoY Growth
2024 $0.59 $0.59 $0.59 $0.615 $2.40 +4.2%
2023 $0.565 $0.565 $0.565 $0.59 $2.29 +5.9%
2022 $0.535 $0.535 $0.535 $0.565 $2.17 +5.9%
2021 $0.505 $0.505 $0.505 $0.535 $2.05 +6.0%
2020 $0.475 $0.475 $0.475 $0.505 $1.93 +6.3%

Analysis completed December 24, 2024 Framework: Warren Buffett / Charlie Munger / Seth Klarman Value Investing Methodology