Why I won't invest in Fortis ($FTS.TO)

A utility company that can't generate free cash is a terrible business

A bit about Fortis

Fortis owns and operates 10 utility transmission and distribution assets in Canada and the United States, serving more than 3.4 million electricity and gas customers.

The company also has some stakes in electricity generation and several Caribbean utilities.

It’s subsidiary ITC operates electric transmission in seven U.S. states, with more than 16,000 miles of high-voltage transmission lines in operation serving a peak load in excess of 23 GW.

The numbers (Last 5 years)

Revenues - 6% CAGR

EBITDA - 10% CAGR

Net Income - 14% CAGR

Operating cash flows - 9% CAGR

Free cash flows - None

Dividend growth - 8% CAGR

Balance sheet

Long term debt - $248 billion, growing at 3%

Short term debt - $21 billion, growing at 6%

Debt/Equity - 1.3

Key return ratios

Return on equity (ROE) - 6%

Return on capital employed (ROCE) - 5%

The critical return ratios are quite low and have been around the same levels since many years. And this is reflected in the long term returns given by Fortis.

That’s a 5% CAGR over the last 5 years.

Assuming the current dividend yield of 3.6% has been consistent since last 5 years and will continue into the future, that’s a total potential return of 8.6%.

A cash hungry business

Fortis is an extremely cash hungry business, as can be seen from the cash flow numbers in the last 5 years.

Operating cash = $136 billion

Capex = $174 billion

Free cash = -$38 billion

Dividends funded from Debt

Since there are no free cash flows coming from the business, where are we getting the dividends from?

Two possible sources

1. Existing cash reserves

2. Debt

Looking the balance sheet of Fortis, we can easily find out that the retained earnings have gone up a bit, but the debt has ballooned as well.

The cumulative debt issued by Fortis since 2017 = $387 billion

I am not sure how long this can go on. The current debt to equity stands at 1.3, so it probably has some leeway left to keep distributing the dividends.

But taking on too much debt is not good for the company and its shareholders.

Bottom-line

Looking at the meagre return ratios and piling debt that is funding the perceived dividend growth, I would rather stay away from Fortis than hope that the business would be able to become cash flow positive in future.

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