FTS: Fortis Inc. Pitch - Queen's...

FTS: Fortis Inc. PitchFebruary 21, 2016

www.queenscapital.ca 2

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The analyses and conclusions of Queen’s Capital contained herein are based on publicly availableinformation. The analyses provided may include certain statements, estimates and projections prepared withrespect to, among other things, the historical and anticipated operating performance of the companies, access tocapital markets and the values of assets and liabilities. Such statements, estimates, and projections reflectvarious assumptions by Queen’s Capital concerning anticipated results that are inherently subject to significanteconomic, competitive, and other uncertainties and contingencies and have been included solely for illustrativepurposes. Actual results may vary materially from the estimates and projected results contained herein.

Queen’s Capital assumes no responsibility or liability for any error, inaccuracy, or omission contained that may bemade of such information by the viewer. No information herein may be replicated without prior consent by theExecutive Board of Queen’s Capital.


Content Slide

Company Overview 4

Macro Outlook 5

Micro Outlook 6

Thesis 7-9

Catalyst/Risk 10

Valuation 11-12

Executive Summary


3 yr. Historic Share Price Operational Overview• Fortis is a North American gas and electric utilities company who also holds

investments in power generation and in commercial real estate and hotels.

• Currently Expanding into the US where government policies better suit their growth needs – the purchase of UNS Energy Corp. and of ITC Holdings Corp.

• Fortis serves a customer base of almost 4,000,000 residential, commercial, and industrial clients

• Negotiating the sale of Walden North Hydroelectric Project as well as the acquisitions of ITC Holdings Corp. and Aitken Creek Gas Storage ULC – total acquisition worth of over $11.5 billion

• 93% of assets are government regulated

• *Fortis sold off the majority of their real estate holdings during 2015

Market Data & 2014 Revenue Breakdown

Overview Macro/Micro Analysis Investment Thesis Catalysts & Risks Valuation Appendix

Company Overview

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Market Data

Mkt. Cap (mm) 10,588 EV (mm) 24,831

Last Close (19/02/16)

38.27 Shares Out. (mm) 281.6

% of 52 –Week High

92% Float (%) 99.6%

Dividend Yield (%)

3.9% Beta 5 yr. 0.03

2015 Revenue 6,727 2015 EBITDA 2,301

2015 Debt 12,192 2015 Net Income 805

UNS Energy

Central Hudson

FortisBC

FortisAlberta

Fortis BC Electric

Eastern Canada

Caribbean

Fortis Generation

Non-regulated non-utility


Continued Performance in a Low Yield Environment

• Low yields on government debt have been forcing investors to seek other sources of low risk, stable returns – pushing them towards stronger utilities like Fortis who have stable dividends and operate in a tightly regulated environment

• Continued low GDP growth figures and inflation rates in North America make it difficult for the Feds to be able to raise interest rates in the short term

• A low interest rate environment will also help them better execute coming executions which will be heavily financed through debt facilities

• Volatile energy commodity prices and uncertainty coming from foreign markets have together contributed to the increase in the volatility of North American equity markets

• The uncertain future of oil prices – especially in the short term – has pushed many investors out of the industry due to current instability and diminished profitability from many oil and gas producers

• The heavily regulated and essential nature of the services provided by utilities make them more stable than other industries in times of volatility and economic uncertainty

• Over the past six months following the market turmoil in late august of 2015 Fortis and the TSX Capped utilities index have both outperformed the S&P TSX, returning 2.74% and 1.53% respectively while the TSX returned -6.73%


Macro Outlook

Volatile Energy Prices & Uncertain Economic Outlook

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60

100

140

Feb-22-2011 Feb-22-2013 Feb-22-2015

TSX:FTS

GCAN10YR

TTUT

85

95

105

115

Aug-20-2015 Nov-20-2015TSX:FTS - Share Pricing ^GSPTSE - Share Pricing

^TTUT - Share Pricing


Canadian Gas & Electricity Transmission Industry Growth Moving Forwards

• $22 billion in revenue generated annually by gas transmission while electricity transmission generates $60 billion a year

• Affected by currently depressed domestic gas prices the industry has had an annual growth rate of -2.7% over the past 5 years

• The electricity transmission industry is currently experiencing growth rates of 3.5% per year

• While revenues have been strengthening over the past 5 years in electricity transmission – due to favorable price trends and stable demand – firms have been experiencing diminished profitability to to high capital outputs to maintain and expand their infrastructure networks

• High levels of government regulation in both industries with means high barriers to entry for new firms and strict compliance measures

• An Oliver Wyman study shows that despite emerging threats from new smart technologies the US utilities industry shows promising revenue growth potential

• Electric utilities revenue growth expected to grow at a rate of 3.3% through to 2030

• In order to meet energy demands in 2030 it is estimated that Canada will need to invest $230 billion into transmission infrastructure – companies like Fortis will see this through increased government support


Micro Outlook

• In August of last year the US Fed developed and finalized the Clean Power Plan (CPP) which will force many states to begin to make the switch from coal to natural gas in order to enhance efficiency

• The shift towards sustainable energy will also benefit industry operators, the FERC has mandated transmission planning which will reduce expansion costs allowing utilities to increase their customer bases

• New “smart-grid” technologies will allow for real-time communication between customers and distributers which will improve system efficiency

Industry Development & Sustainability Projected Industry Revenue Growth

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400,000.00

440,000.00

480,000.00

2016 2017 2018 2019 2020 2021


Strong Margins & Efficiency

• Fortis’ margins exceed the average of their peers indicating lower sensitivity to changes in price and demand

• Strong margins allow Fortis to maintain higher levels of efficiency than other utilities, with returns on assets, capital, and equity surpassing those of similar sized US and Canadian Utilities

• Fortis has been able to effectively integrate new acquisitions into its existing operations with no negative affect on efficiency - is also true for their expansion into the US utilities market

Revenue and Asset Base Growth

• Fortis has a fair amount of leverage compared to competitors with ~54% of capital base being made up of debt this will help drive ROE and accelerate growth moving forward

• Fortis has experienced average top-line growth of 22.9% over the past 3 years and 13.7% over the past 5 – this is expected to continue through an acquisition based growth strategy

• Asset base has grown significantly since 2010 while still maintaining a consistent capital structure


Investment Thesis I: Growth & Efficiency

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2010 2011 2012 2013 2014 2015

EBITDA Margin %

EBIT Margin %

Net Income Margin %Return on Equity %

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FTS Median

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Investment Thesis II – ITC Deal

Implications of Announcement for Company – A New Point of Leverage


Accretive• Promises better growth in a time of flat electricity demand and rising capital costs• Aligns with Fortis' financial objectives by providing approximately 5% EPS accretion in the first full year following closing, excluding one-time acquisition-

related expenses. Fortis continues to target 6% average annual dividend growth through 2020

Diversification• Allows FTS to diversify through regulatory jurisdictions, business risk profile and regional economic mix as ITC is expected to represent almost 40% of the

consolidated regulated operating earnings of Fortis• Geographic diversification by expanding beyond current five Canadian provinces, New York, Arizona, and three Caribbean countries, to expand into eight

additional U.S. states

Supportive FERC • FERC regulates ITC’s tariff rates which has been a consistently supportive utility regulator using a forward-looking rate-setting mechanism with an annual

true-up, which provides timely cost recovery and reduces regulatory lag to provide reasonable returns and equity ratios

Long Term Outlook• Transmission earnings are not dependent on usage, so there’s no risk from declining electricity consumption• Based on ITC's planned capital expenditure program, ITC's average rate base and CWIP is expected to increase at a compounded average annual rate of

approximately 7.5% through to 2018. With ITC, Fortis expects to capitalize on construction of new high-voltage lines as the administration of President Barack Obama encourages development of wind farms and other sources of renewable energy

• Clean Power Plan ("CPP") is expected to drive investment in renewables in the U.S. ITC is therefore a strong candidate to participate in the transmission investment opportunity

• Largest US independent transmission utility • ITC owns and operates 15,600 miles (25,100 kilometers) of high-voltage

lines in Michigan, Iowa, Minnesota, Illinois, Missouri, Kansas and Oklahoma and can deliver over 26,000 megawatts

• Fortis intends on retaining all of ITC's employees and maintaining the corporate headquarters in Novi, Michigan 11% 11% 10% 10%

4% 3% 2% 2%

22% 28% 26% 25%

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16% 17%

48% 43% 46% 46%

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2014 2015 2016 2017

Projected Transmission CAPEX by Activity

Transmission or New Build

Replacement of Existing Lines/Facilities

Fundamental Improvements

Advanced Technologies

other


• With the recent sale of its commercial real estate portfolio and hotel assets in October, as well as the disposition of its non-regulated generation assets, Fortis is composed of nearly 100% regulated utilities and long-term contracted energy infrastructure.

• Following the acquisition of ITC by the end of 2016, Fortis will become the largest highly regulated investor-owned utility in Canada. This can represent a solid defensive play with attractive valuations.

• Growth will be driven by future utility investments in Canada, U.S., and possibly beyond. Acquisition of ITC provides attractive entry into the underinvested U.S. transmission industry


Investment Thesis III: Strong, Sustainable Returns

Favorable Geographic Exposure

Low Risk Regulated Earnings Robust Investments & Significant Capital Return

• ITC is the largest, independent American transmission company. 100% of its earnings are FERC regulated. Pro-forma statements show that with the acquisition of ITC, 40% of Fortis’ total earnings will be under the governance of FERC

• FERC is a supportive regulator that aims to incentivize investments in the transmissions sector. Its long term policy for incentivizing investments provides constructive ROE’s above 11% and required equity thickness of 60%. This is viewed favorably relative to Fortis’ current operations in Canada and other jurisdictions in the U.S.

• ITC is positioned in the heartland of the U.S. This is where the majority of the regional developments are estimated to be, particularly for wind power. The Clean Power Plan unveiled in August, 2015 aims to reduce CO2 emissions by 32%. This will help drive transmission investments in the upcoming years

• Fortis has increased annualized dividends for the past 42 years, which represents the longest record of any public corporation in Canada. Average payout ratio over the past 5 years is ~68%.

• In 2015, Fortis hiked dividends twice, which represents a 17% increase over 2014. Guidance for dividends has indicated 6% annualized growth until 2020, driven by a $9B five year base capital plan


Catalysts & Risks

Risks

Regulatory Foreign Exchange

• ITC plans to invest about $3 billion in new lines and improvements through 2018

• FERC regulated operations, with substantial rate base growth and robust investment opportunities add a new growth platform

• LNG projects proceeding to help fuel BC Ferries' three new intermediate class ferries


• Still needs approval from ITC Transmission, Michigan Electric Transmission Company (METC), ITC Midwest, ITC Great Plains which are all within the jurisdiction of the FERC

• Along with state from the FERC, the Committee on Foreign Investment in the US, and the US Federal Trade Commission approvals, ITC also require shareholder approval

• Closing expected end late 2016

Aggressive Expansion

Funding

Catalysts

Foreign Exchange

• Given the private capital funding issue the large amount of equity to ITC shareholders and typical utility deal timeline the foreign exchange risks around USD/CAD are notable for the ITC transaction

• Can be challenging in respect to future flow back concerns upon deal close as approval process progresses

• There were expectations for more funding from an alternative capital source (pension funds, sovereign wealth funds, infrastructure funds) which would have lessened the share exchange and minimized flow back concerns

• Now facing de-rate risks as FTS de-rated recently with Fitch and lack of a named investor may deflate public and private market valuations

• Material weakness in the Canadian dollar may help ITC if they leverage their operations in the US and Canada appropriately

Mitigation: currently on track with regulatory approvals and ITC is currently over seen by the FERC

Mitigation: US debt and share exchange even though US dollar expected to remain strong through to 2017

Mitigation: maintaining public confidence that ITC deal won’t be dilutive


• Relatively high Price to Earnings • Attributable to their stable cash flows and recent drop in stock price due to announcement of ITC• Looks like undervalued compared to other industry competitors

• One of the only positive YTD Returns• Industry suffering over the past year but FTS has managed to sustain cash flows and growth to lead to a positive return

• Largest by Market Capitalization• With acquisition of ITC, Fortis will also become one of the top 15 North American public utilities ranked by enterprise value

Valuation I – Comparables

CAD$

Price Mkt Cap (B) Forward P/E

P/E ROE DE Yield EV (B) EV/EBITDA (TTM) Forward EV/EBITDA

EBITDA growth ROIC BV/Share YTD Return

Hydro One (H) 22.30 1.85 19.58 20 10.22% 2.80% 22.72 11.62 11.76 -0.70% 6.45% - 0.09%

Emera Inc (EMA) 43.65 6.20 18.9 13.53 16.93% 4.35% 10.86 11.23 5.93 39.98% 8.43% 18.10 1.04%

Capital Power Co (CPX) 17.70 1.76 16.43 23.69 2.84% 8.25% 3.86 8.16 8.04 -17.89% - 19.56 -0.51%

Just Energy Group (JE) 8.90 1.31 18.61 8.91 - 5.61% 1.91 10.61 8.01 0.08% -31.86% 6.84 -9.87%

Transalta Corp (TA) 4.22 1.20 47.99 6.58 -4.55% 17.08% 7.36 8.59 8.04 34.73% 0.61% 5.99 -14.15%

Inter Pipeline (IPL) 21.53 7.24 16.52 19.39 13.94% 6.91% 10.98 12.28 12.29 12.62% 7.88% 6.56 -2.36%

Shawcor LTD (SCL) 27.18 1.75- 17.44 9.93% 2.21% 2.06 8.39 9.48 - 5.38% - -3.10%

Suncor Energy (SU) 30.93 44.74 18.61 43.06 2.53% 3.75% 54.28 4.54 9.51 - 4.12% - -13.39%

Whitecap Resources (WCP) 7.18 2.14 52.66 7.37 10.32% 10.42% 2.94 3.19 8.04 117.40% -12.37% - -20.40%

Fortis (FTS) 38.27 7.81 17.71 14.77 11.38% 3.64% 24.51 10.87 9.98 80.20% 5.50% 28.63 2.30%

Mean 22.19 7.60 25.22 17.47 8.17% 6.50% 14.15 8.95 9.11 33.30% -0.65% 14.28 -6.04%

High 43.65 44.74 52.66 43.06 16.93% 17.08% 54.28 12.28 12.29 117.40% 8.43% 28.63 2.30%

Low 4.22 1.20 16.43 7.37 2.53% 2.21% 1.91 3.19 5.93 -17.89% -31.86% 5.99 -20.40%

Median 21.92 2.00 18.61 16.11 10.22% 4.98% 9.11 9.60 8.76 23.68% 5.38% 12.47 -2.73%


Valuation I – Discounted Cash Flow

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