Fortis and the Regulated Utility Return Formula

Fortis operates almost entirely under regulated frameworks where a regulator sets an allowed return on equity applied to an approved capital base. Everything about the investment case follows from that. Once an investor understands the formula that produces earnings, most of what appears in quarterly results and investor presentations becomes a variation on the same underlying mechanics rather than a series of surprises.

The formula

Earnings approximate the allowed return on equity multiplied by the equity portion of rate base. Growing earnings therefore requires growing the rate base — building or upgrading infrastructure that regulators approve for recovery — or securing a higher allowed return, which is rare. Rate base is the value of the assets a regulator recognizes as used and useful in providing service, and it grows as the company invests capital in new or replacement infrastructure that passes regulatory review. Because the allowed return on equity is set through periodic regulatory proceedings and tends to move only modestly and infrequently, the far more reliable and controllable lever for earnings growth is simply investing more capital into the regulated asset base, provided that spending is prudent and gets approved for recovery.

The capital plan is the forecast

The company's multi-year capital plan is effectively an earnings forecast, subject to regulatory approval and financing. This is why utility investors scrutinise capital plans more closely than quarterly results. A quarterly earnings report reflects decisions and investments made years earlier; the capital plan reveals what earnings growth will look like several years into the future, which is the more decision-useful piece of disclosure for a long-term holder. Because the plan spans multiple regulated subsidiaries across different jurisdictions, each with its own regulatory timeline, investors need to track not just the aggregate capital spending figure but the extent to which each component of the plan has already cleared regulatory review, since spending that has not yet been approved carries more execution risk than spending already sanctioned.

Financing the plan

A large capital program has to be funded, typically through a mix of retained earnings, debt and periodic equity issuance. Because rate base growth is the central driver of the thesis, the ability to finance it without impairing the balance sheet or diluting shareholders excessively is itself part of the investment case. A utility that needs to issue equity at a discount to fund its capital plan is effectively giving back some of the earnings growth the plan is meant to deliver, which is why the pace and terms of any financing activity deserve as much attention as the capital plan itself.

Rate sensitivity

As a bond proxy with a large debt load, the shares trade inversely to long yields in the short run. Over longer horizons rate-base growth dominates, which is why the sector rewards patience rather than timing. In the short term, the stock's dividend yield is often compared directly against long-term government bond yields, so when those yields rise, the relative appeal of the utility's yield diminishes and the shares tend to underperform, independent of anything happening operationally. Over a multi-year holding period, however, the compounding effect of rate base growth and the associated earnings and dividend growth tends to outweigh the noise created by short-term interest rate moves, which is the central argument for treating the shares as a long-duration holding rather than a trade.

What to watch

Track the multi-year capital plan and the proportion of it that has cleared regulatory approval, along with the outcomes of allowed-return-on-equity decisions in the company's key jurisdictions. Watch the financing mix used to fund the capital program, including the pace of any equity issuance, and monitor the dividend growth rate relative to earnings growth as a signal of how sustainably the payout is being funded.