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Fortis: US utilities can boost rate base, CapEx more quickly under new tax law

Executives at Fortis Inc. expect 2018 earnings to be affected by a new U.S. tax law but said the new law will allow the Canada-headquartered company's U.S. utilities to increase their rate base and capital spending more quickly.

In the fourth quarter of 2017, Fortis reported a noncash write-down of C$146 million related to the new U.S. tax law which contributed to lower earnings earnings of 32 Canadian cents per share, down from 49 Canadian cents per share in the last quarter of 2016, according to the company's Feb. 15 earnings release. The company reported full-year net earnings in 2017 of C$2.32 per common share, down from C$1.89 per share in the same quarter of 2016.

On an adjusted basis, Fortis earned 62 Canadian cents per common share in the fourth quarter of 2017, down a penny from levels in the same quarter of 2016. Adjusted earnings in 2017 were C$2.53 per common share, up 22 Canadian cents per share from 2016 levels and in line with consensus estimates from S&P Capital IQ.

Favorable performance at its U.S. transmission company ITC Holdings Corp. and its Arizona-based utility UNS Energy Corp., as well as its Aitken Creek underground storage facility in British Columbia, helped lift full-year 2017 earnings higher despite the fourth quarter one-time charge from the U.S. tax reform law. The Tax Cuts and Jobs Act, which President Donald Trump signed Dec. 22, 2017, lowers the corporate tax rate to 21% from 35% and eliminates bonus depreciation of utility property, a feature which helps cash flows by letting utilities put off immediate expensing of capital projects.

Fortis Executive Vice President and CFO Karl Smith expects the company's 2018 earnings per share to be reduced by about 3% because of impacts of the new tax law and deducting interest at the 21% rate. After 2018, Smith expects the 3% headwind to be offset by growth in utility rate base and capital spending.

"Going forward, the impact of U.S. tax reform will increase rate base growth over the five-year period to 2022 by approximately 50 basis points" from its prior forecast level, according to the company's annual report dated Feb. 14. Smith expects the company's revenues from rates by 2022 to be about C$700 million higher than previously forecast.

Regarding the 3% hit to 2018 earnings, Fortis President and CEO Barry Perry said, "Now we have taken a little bit of a smack ... from U.S. tax reform, but we are going to come back above that very quickly over the next year. A pretty minor hit overall." Now that bonus depreciation is gone for the utility sector, "it is going to allow every dollar of investment to help rate base grow at a quicker rate," Perry added.

Perry and Smith also expect the U.S. Federal Energy Regulatory Commission, which regulates interstate natural gas pipelines and transmission projects, to weigh in on tax reform and impacts to transmission rates. Though Perry expects "fairly significant decreases in transmission rates" across its utilities from FERC action, "we are hopeful, obviously, that will allow more opportunities to invest further in some of the service territories" in terms of capital investment.

Analysts on the call were also concerned about cross-border differences in tax treatment, such as cash flows that are eligible for a tax deduction in the U.S. but not in Canada. Smith said there is a still "a little bit of grey" on the topic, but the company's analysis so far suggests "if there was to be an impact, it would be very small."

Several analysts asked about growth and whether more acquisitions are in Fortis' plans. But after three major U.S. acquisitions in five years, Perry said he is mainly focused on further growth at the utility businesses and allocating capital across those subsidiaries.

The company maintained a C$14.5 billion capital spending plan for the 2018 to 2022 period. There is a lot of opportunity to upgrade reliability in the midwestern U.S. and building new transmission to eliminate the need for new generation, Perry said. The CEO is also "optimistic" about investments in UNS' service territory such as a 2,000-MW pumped storage project in Arizona that ITC proposed in October 2017.

Fortis' five-year CapEx plan allots about C$350 million in the 2019 to 2022 period for FortisBC Holdings' Eagle Mountain Woodfibre project, a roughly 29-mile gas line proposed to facilitate export of liquefied natural gas to Asia, according to a January investor presentation. Should the project proceed, Fortis expects it to be on line before 2021, according to its annual report.