Algonquin Power and Utilities (AQN.TO – C$4.70, AQUNF.PK - $4.61) is a small-cap Canadian electric generation company focused on renewable, clean power and water utilities. The company manages a billion dollars in utility assets in the US and Canada. Expansion into California and rate increases in their water utilities should positively impact cash flow. While the first half of ’10 generated lower earnings, the second half of ’10 should be an improvement.
Algonquin owns 60 electric generation facilities in Canada and the US, comprising of 47 hydro-electric, 12 thermo-electric, and 1 wind farm. In addition, AQN operates 19 water utilities in Illinois, Arizona, and Texas. About 50% of revenues are derived from renewable facilities, 25% from water utilities, 18% from thermo-generation (mainly natural gas) and 7% from bio fuel plants.
AQN manages about 480 MW of installed capacity, about two thirds of which are from renewable sources, mainly generated at smaller plants. Hydropower is a large component of AQN’s generation profile.
For the first 6 months, revenues decreased by 10%, or $9 million, to $90 mil. This past summer, power generation from both water and wind resources were down by about 5%. An unexpected mechanical outage at the waste plant along with a change in the operating model at another facility combined to reduce generation by an additional 5%.
Six-month earnings reflected the reduction in revenues and production, with AQN earning of just C$0.01, or C$1.2 mill, versus C$0.25 or C$19.1 million in ’09. Earnings were also negatively affected by mark-to-market of derivative financial instruments, foreign exchange contracts, interest rate swaps and energy forward purchase contracts. At C$12.5 million, these write-offs dwarfed the $3.9 million reduced operating shortfall or the C$3.4 million combined increase in interest paid and taxes. Look for 3rd quarter earnings around Nov 23.
Operating cash flow held better, declining from C$29 million or C$0.29/shr to C$21million or C$0.23/shr.
Revenues are expected to be flat in ‘10 at around C$187 million. Stock market capitalization is C$440 million, and long-term debt is C$423 million. There are 95 million shares outstanding, and an additional 35 million shares will be issued from convertible debentures in 2014 to 2017. EPS is estimated at between C$0.01 and C$0.20 for 2010 (down from estimates in the $0.30 range in the spring) and between C$ 0.17 and C$ 0.33 in 2011 (down from $0.35 range in the spring). 2010 operating cash flow is expected to be in the $C40 million range, making the current C$0.24 dividend payout ratio of 57% comfortable for a utility.
There are several positive aspects of Algonquin that utility investors should focus on:
- Rate cases in the water business have been favorable for AQN. Annualized, 2010 rate increases should generate about C $14 million of added revenue. In 2011, the increase should flow directly to the bottom line. With water uts trading at around 10x EBDITA, this should equate to an additional $1.47 a share in valuation.
- Algonquin is developing a strong relationship with Canadian Maritimes electric utility Emera (EMA.TO, OTCPK:EMRAF). AQN and EMA are acquiring the assets and will jointly operate an electric generation and transmission system in Lake Tahoe, California. The acquisition was recently approved by the US courts and closing is expected late 2010, adding 47,000 customers. In connection with the Lake Tahoe acquisition, EMA has agreed to purchase 8% of AQN stock. The strategic alliance being built between EMA and AQN should be beneficial to both companies over time.
-The acquisition of the California power generation and transmission assets will add to the diversified portfolio of energy resources. The more-stable water utility cash flow helps to offset some volatility of the hydro-business.
- Anticipated operating cash flow after dividend payment could allow for investment in new capacity of upwards of C$35 million annually. This could fund one 25MW wind farm a year, or about 4 to 5% capacity growth, without adding much additional dilution or leverage.
-With earnings, operating cash flow, and EBDITA are expected to grow in 2011 and 2012, there may be room for a dividend increase. Earnings are expected to expand to as much as C$31 million, ocf to C$80 million, and EBDITA to C$108 million. Increasing the dividend from C$0.24/shr to C$0.25 would represent a 5% raise, and would represent a payout of just under C$24 million. This increase could be comfortably funded by improving financials. AQN could increase the dividend again in 2012.
Investors looking for small-cap alternative energy electric utility should consider Algonquin. I believe there is a possibility for share prices to recoup to the C$5.70 range. The current yield, while not overly substantial, should be sufficient to reward shareholders looking for the combination of income and growth.
While C$6 would be richly valued and offer a sub-par 4.0% implied yield, AQN is uniquely positioned in the renewable power generation business. If any surprises are announced, they should be to the upside. Algonquin is worthy of your due diligence and a great place to start is a list of their generating plants and the recently published 2010 First Half Report, both found on their website here and here.
As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.
Disclosure: Long AQUNF.PK and have been a shareholder since 2009