Should You Continue To Hold On To Altagas And Its 9.2% Yielding Dividend?
Summary
- Altagas owns and operates a diversified energy infrastructure in North America.
- The company is still waiting for the final regulatory approval to close its acquisition of WGL Holdings.
- The company expects to increase its dividend by 8 to 10% through 2021.
- Less than 10% of its EBITDA are directly related to commodity prices.
Investment Thesis
Altagas (OTCPK:ATGFF) (TSX:ALA) owns and operates a diversified energy infrastructure in North America. It has a low-risk business model as less than 10% of its EBITDA are directly related to commodity prices. The company expects to increase its dividend by 8 to 10% through 2021. While its shares continue to decline due to the uncertainty regarding the acquisition, its dividend remains safe and sustainable.
Source: Investor Presentation
Reasons why investors with a long-term horizon will be rewarded
Its Utilities Segment Offers Stable and Predictable EBITDA
After the closing of its WGL acquisition, about 50% of Altagas' EBITDA will come from regulated utilities (natural gas). This segment of its business is extremely low risk with stable and predictable EBITDA.
Source: Investor Presentation
Highly Contracted, Low-Risk Business Model
Beside its stable and predictable utilities segment, Altagas' power generation and midstream pipeline business are also highly contracted. As can be seen from the bottom left pie chart, the company's commodity based EBITDA is expected to only represent 9% if its total EBITDA in 2019 (after WGL acquisition). This means that 91% of its EBITDA in 2019 do not have any exposure to commodity pricing. In addition, 85% of its EBITDA will come from long-term agreements (see bottom right pie chart).
Source: Investor Presentation
RIPET to provide Significant Cost Advantages to Ship its propane to Asia
Altagas' Ridley Island Propane Export Terminal ("RIPET") is expected to be in-service in the first quarter of 2019. This C$450 to C$500 million project has a locational advantage given very short shipping distances to markets in Asia. As can be seen from the map below, to ship propane to Asia through its export terminal will take only about 10 days to reach Japan or Korea. On the other hand, to ship propane from the U.S. Gulf Coast will take about 25 days. Altagas' RIPET facility is designed to export about 40,000 bbls/d.
Source: Investor Presentation
8% to 10% Dividend Growth Expected through 2021
Investors seeking for dividend growth will be glad to know about Altagas' dividend prospect. The company currently pays a monthly dividend of C$0.1825 per share. This is equivalent to a dividend yield of 9.3%. The company expects to increase its dividend at a compound annual growth rate of about 8% to 10% through 2021.
Investors should not be concerned about its dividend sustainability as its dividend payout ratio as a percentage of 2018 forecasted AFFO is near 80% (see bottom right chart). The reason for the high dividend yield is due to its weakness of share price primarily due to uncertainty of the acquisition and the recent declining share prices of utility stocks.
Source: Investor Presentation
But investors are concerned about its WGL acquisition
As we have shown in the article, the combined Altagas and WGL business should be seen positively. However, its shares have continued to decline. In fact, it has dropped to a 52-week low on March 2, 2018.
There are several reasons why I believe might have contributed to the recent share weakness:
1) U.S. Tax Reform will negatively impact its EBITDA
In its recent conference call, management expressed that Altagas' normalized EBITDA and normalized FFO will be reduced by approximately 5% as a result of the U.S. tax reform. While management believe it is not material, a 5% reduction is enough to cause a correction to its share price.
2) Paying a premium for WGL Acquisition
While management continues to express its view that the WGL acquisition will be accretive, the problem may lie on the price that Altagas will pay to acquire WGL. In January 2017, the company announced to purchase WGL with a price of US$88.25 per share. The announcement of the acquisition has resulted in a surge of WGL's share price by over 30% (see graph below). In the past year, other utility stocks have first reached the high in November 2017 before falling back to the same level as before. Please see the graph below. The recent share price decline of other utility stocks (I am using Utilities Select Sector SPDR ETF XLU as my reference) makes Altagas' WGL acquisition less attractive as well. Given that we are in a rising interest rate environment, utility stocks may continue to perform poorly. No wonder Altagas' shares continue to sink.
WGL data by YCharts
3) Uncertainties Regarding Merger and Regulation Approval
In addition to the uncertainties regarding the sale of its non-core assets, Altagas' merger also require regulatory approval from Washington, DC. Although approval is likely, it is difficult for investors to gauge what its business will be like in 2018. In addition, Altagas has previously said that they would sell some of its power assets (Blythe and Tracy power facilities) in California. However, in the past conference call, the company indicated that they would keep these assets. This makes it difficult for the market to estimate the impact of the disposition of non-core assets on its EBITDA. Many investors might simply decide that it might be better to put their money elsewhere then patiently waiting for the acquisition to close.
Source: Investor Presentation
Should Investors Continue to Hold on to the stock?
The challenge for investors now is whether to hold on to their Altagas shares given that its share price has dropped nearly 25% in the past year. However, its dividend is both secure and safe (even after the merger). Investors may want to continue to reinvest the dividend by participating in Altagas' dividend reinvestment plan and take advantage of the 3% discount the company offers for qualified investors. I believe once the uncertainty regarding its acquisition resolves, the road ahead will be much smoother.
One of the purposes of this article is to provide a platform for readers to share their view and opinion. Please feel free to share your opinion in the discussion section to enrich the content of this article.
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Analyst’s Disclosure: I am/we are long ATGFF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (31)
The Wash DC area certainly would have a few politicians to contend with as well.
In some ways it might be merciful if WGL just gets rejected.
No editorials just looking at the potential use of capital on other projects rather than WGL 's old pipes.
The California plants another potential expense. The gas ute NWN just wrote off gas storage facilities there due to price of gas and California legislation.
The bottom line here is their are many utes and facilities to aquire, just make sure the other tangibles don't eat all cash flow now and forever.
part, stated they "will not be able to make the required findings… …that the
Merger is in the public interest, provides benefits to consumers, and results in
no harm to consumers."May be the reason for the recent weakness. More goodies for both Washington DC and Maryland? Could they be in a "competition" to see who can get the most out of AltaGas before approval? I knew the Wash DC regulators were going put their grubby hands in the pie, but Maryland also? Did a bit more ATGFF nibbling at these levels
(2) Interest expense grew substantively YoY, well in advance of the planned WGL closing date. [Addendum - I also noticed the increase in preferred-share payout, which is akin to interest expense. I like to see earnings increase when leverage from debt and pseudo-debt increases.]If anyone with deeper knowledge of the company feels able to comment on these two points, please do. The drop in earnings has been discussed and modeled elsewhere, but it's worth some time as well.
However, I don't agree with reason #2: "2) Paying a premium for WGL Acquisition"
The price was a known fact, way before the recent Q4 release and subsequent selloff.I like the co's assets but I am not sure about the portfolio of gas-fired power plants in CA. I understand there are no long term power purchase agreements and let's face the reality: Gas is a fossil fuel, a Taboo in CA.
Best case scenario if kept alive, gas plants may be given a part-time job to back up renewables, cannibalizing the high efficiency of combined-cycle power plants.
What may help is a drought or low water levels which will cut power production of California dams. But this is an unknown factor as well as hot summer weather. I think, unless Alta or the combined company can secure a good long term future in CA, these plants are better to go.
What has changed the original plan to sell these assets? It could be no willing buyers, or it could be that WGL said they can deal with greens and socialists in CA - we can only speculate.
But Altagas also owns about 5 or 6 gas-fired plants in CA. The largest, 507 MW Blythe has a PPA expiring in 2020 and 330 MW Tracy in 2022. Relatively short term power purchase agreements and there is only hope that these plants will be welcomed to stay in CA and be given at least a minimum share to operate with a profit.
I still like the original plan to sell these assets and use proceeds to finance the acquisition. In general, I like the efficiency and flexibility of combined-cycle power plants and their important role in retiring coal. But I would stay away from CA - bad place to own and operate gas plants.
And if the deal goes through you are losing $1 on your shares overnight if you buy the receipts...
