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ANALYSIS: Attractive dividends at a bargain price are poised to make Hydro One Ltd. a smooth sell in a difficult market for initial public offerings when it prices this week, making it Canada’s largest utility by market value. The greening of its home province may be an overlooked allure.
Ontario is seeking to raise as much as $1.87 billion by selling 15 percent of the provincially owned utility with shares priced at $19 to $21 apiece in what could be Canada’s biggest IPO in 15 years. Royal Bank of Canada and Bank of Nova Scotia are leading the sale.
The electricity distribution and transmission company is set to hit the public market with the power system in Canada’s most populous province in flux. The fragmented industry is ripe for consolidation while an increase in wind and solar power means the grid will need to expand to connect supply with demand.
“We’re going to see less coal and more gas and renewables in the U.S. and Canada,” Charles Fishman, a utilities analyst at Morningstar Inc. in Chicago, said by phone. “And this is going to be good for transmission utilities because the load is not where renewables are.”
Utilities across North America are being forced to adjust to an electricity system that is becoming less centralized as large coal plants are shuttered in favor of renewable energy. That’s creating an opportunity for companies to grow by expanding or rebuilding their existing network of power lines or taking over rivals.
Ontario has already closed down its coal power plants, including North America’s largest, and replaced some of that capacity with a combination of more natural gas and renewable sources. That means more wires.
“These trends are good for investment in transmission,” Fishman said.
Even at $19 apiece, Hydro One would have a market value of $11.3 billion, ahead of Fortis Inc. at about $11 billion and Canadian Utilities Ltd. at $9.4 billion, according to data compiled at Bloomberg. It would rank among the top 20 largest North American utilities.
The company’s dominant size would provide it with a chance to buy up smaller competitors in Ontario. The province currently has about 70 smaller distribution competitors, many of which are owned by towns and cities across Ontario. Daffyd Roderick, a spokesman at Hydro One, declined to comment.
“Hydro One will continue to evaluate local distribution company consolidation opportunities in Ontario in the future and intends to pursue those acquisitions which deliver value to the company and its shareholders," the utility said in its Sept. 17 prospectus. Hydro One also said it may consider "larger-scale acquisition opportunities or other strategic initiatives outside of Ontario" including transmission and distribution providers in Canada or the U.S.
“Prospects for new investment would drive the interest in these kinds of offerings,” said Steven Paget, an analyst at FirstEnergy Capital Corp. in Calgary.
The company last year reported revenue of C$6.5 billion and net income of C$747 million. It owned C$23.2 billion worth of assets including about 29,000 kilometers (18,000 miles) of transmission lines as of June 30 and served about 1.3 million distribution customers, according to sale documents.
Hydro One’s proposed annual dividend of 84 cents would yield about 4 percent, above the 3.3 percent average yield among its Canadian peers and 3.9 percent for the 13-company S&P 500 Electric Utilities Index, according to data compiled by Bloomberg.
Hydro One is pursuing an IPO at a difficult time, with volatile stock markets causing havoc for North American companies trying to raise funds. Canada has only had two other domestic IPOs above C$100 million in the past three months -- both special purpose acquisition corporations.
Initial sales for telecommunications firm exactEarth Ltd. and home builder Tricon Investment Partners Inc. were scrapped due to market conditions. CPI Card Group Inc., a payments card maker that dual listed in the U.S. and Canada, was forced to slash its IPO by half earlier this month due to "heightened volatility."
A volatility gauge for 60 of the largest, most liquid Canadian stocks surged as much as 27 percent in the first two weeks after Hydro One filed IPO documents with regulators, and is currently down 18 percent from the initial filing date.
Hydro One expects 4.2 percent annual growth in the rates charged to customers through 2019, according to a regulatory filing ahead of its share sale. The regulated rates cover 99 percent of the company’s revenue.
Bruce Campbell, who manages about C$100 million at Stone Castle Investment Management Inc. in Kelowna, British Columbia, said the price range makes the valuation seem "pretty reasonable" when compared to its peers. At C$19 the company would have a price to earnings ratio of 16.3 for 2014, according to the sales documents. That compares with 21.5 for Fortis and 16.8 for Canadian Utilities in 2014, the documents show.
The IPO will likely sell out, Campbell said, based on conversations with other investors and those marketing the deal.
"They didn’t think it was going to fly off the shelves and be five-times oversubscribed, but they felt it was going to be fully covered and go out the door, no problem, somewhere in the range," he said. He hasn’t decided whether he will buy the shares.