Algonquin: Boost Your Dividend Income With This Fast-Growing Utility

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About: Algonquin Power & Utilities Corp. (AQN)
by: Steve Brodrick
Summary

Algonquin has demonstrated an ability to grow assets and EPS through strategic acquisition, organic growth, and effective capital development.

Algonquin’s regulated utility model provides revenue stability and limits risk.

Since 2009, Algonquin has increased its dividend at a CAGR of >10%. These dividend increases have been well covered by a 5-year CAGR in EPS of >20%.

Algonquin’s $7.5B project portfolio will continue to grow EPS and support dividend growth out to 2023.

Investment Thesis

Algonquin Power &Utilities Corp. (AQN) is a stable dividend-paying utility company with a tremendous growth profile. The firm has extended a record of impressive EPS growth through accretive acquisitions, effective capital investment, and organic growth. Algonquin combines the stable cash flow of a regulated utility with a record of consistent and continued growth. In addition to capital appreciation, Algonquin has a long track record of growing its dividend. Since 2009, dividends on common shares have increased at a CAGR of >10%. These dividend increases have been well-covered by a 5-year CAGR EPS of >20%. Algonquin’s $7.5B project portfolio of will grow EPS and support dividend growth out to 2023.

Image result for algonquin power

Source: Algonquin Power & Utilities Corp.

Company Profile

Algonquin Power & Utilities Corp. trades on both the Toronto Stock Exchange and the New York Stock Exchange under the symbol AQN. Algonquin is a diversified generation, transmission, and distribution utility operating as Liberty Utilities and Liberty Power. Liberty Utilities is a provider of rate regulated natural gas, water and electricity generation, transmission and distribution utility services to over 766,000 customers in the United States. Liberty Power is a clean energy producer with wind, solar, hydro, and thermal assets. Algonquin is a mid-sized utility provider with a current market capitalization of approximately USD $5.35B.

Source: Algonquin Power & Utilities Corp.

Growth Profile and Development Pipeline

As a mid sized utility, Algonquin Power & Utilities has achieved impressive growth over the last decade. It is a serial acquirer, having completed some 24 accretive utility acquisitions since 2009. In 2018, AQN increased total liquidity in order to execute on potential acquisition opportunities as they arise. One of these recent acquisitions was the addition of New Brunswick Gas, marking an entrance into the regulated utility space in Canada.

Aside from maintaining some dry powder for future acquisitions, Algonquin is advancing a $7.5B capital investment plan from 2020-2023. The bulk of Algonquin’s capital development allocation, $5.3B, will be in regulated utilities. The firm will invest $1.7B in renewables and a further $0.5B on international expansion. Most of Algonquin’s revenue is derived from Liberty Utilities, which is why over 70% of capital expansion through 2023 will be allocated to growing this lucrative division. This sizable project development pipeline will be funded by a combination of cash flow, equity, and debt, with a significant portion being advanced organically.

Source: Algonquin Power & Utilities Corp.

Recent highlights from the Liberty Power division include the completion of a wind project on Amherst Island in Ontario, Canada comprised of 26 new turbines. 2018 also saw the completions of the Great Bay Solar Project, a 300,000 panel installation in southern Maryland. These two projects represent the firm’s 12th wind and 4th solar project. The addition of these two facilities will add a combined ~380 MW of electrical output for Liberty Power. Algonquin’s current capital plan for Liberty Power includes the development of seven new facilities that will generate more than a gigawatt of new power. Algonquin has a number of other wind projects that will add incremental capacity across the Midwest, in an initiative endorsed by utility regulators that will both help reduce power costs for customers and add 600 MW of new capacity.

Liberty Utilities is currently in the development phase of the Granite Bridge project, a natural has pipeline and storage facility. The 26-mile gas pipeline to be constructed in New Hampshire will help provide relief for a bottle neck in this part of Liberty Utilities’ north east transmission network. Liberty Utilities has also undertaken a minority position in a joint venture with Fortis (FTS) and local First Nations groups on a $1.6B transmission project in Northern Ontario.

Source: Algonquin Power & Utilities Corp.

International Expansion

Algonquin has pursued opportunities for overseas expansion in recent years including assets in South America and Africa. In 2018, Algonquin purchased a 41.5% equity interest in Atlantica Yield (AY). Atlantica owns and manages a diversified international portfolio of contracted renewable assets including power generation, electric transmission, waste water, and desalination. Algonquin has also formed a partnership with Spanish multinational, Abengoa S.A. (OTCPK:ABGOF) to create AAGES (Abengoa-Algonquin Global Energy Solutions). Through these interests and joint ventures, Algonquin has pursued a number of international projects including an electrical transmission line in Peru. Algonquin is also advancing a transmission concession in Panama and an opportunity for a desalination facility in Chile.

Caption: International Opportunities

Source: Algonquin Power & Utilities Corp.

Dividend Growth

Algonquin targets an industry-leading dividend policy with a commitment to grow dividends along with growing EPS and EBITDA. With a current yield of ~4.65%, Algonquin offers an attractive yield. The firm has increased its dividend for the last eight consecutive years. In Algonquin’s recent earnings call, CEO Ian Robertson expressed the firm’s commitment to dividend growth.

We are very mindful of the core role that our dividend plays in the total return expectations of our shareholders, signalling their continued conviction in the growth and stability of our business as our Board of Directors approved 10% increase in our dividend again in 2018.

Since 2009, dividends on common shares have increased at a CAGR of >10%. These dividend increases have been well covered by a 5-year CAGR EPS of >20%. As EPS growth has outpaced the rate of dividend increases, Algonquin’s payout ratio has declined over recent years to its current level of ~85%. The firm targets 9-13% CAGR for EPS out to 2023 based on its organic growth and development pipeline. This growth will continue to support ~10% annual dividend increases out to 2023.

0.50 0.40 U.S.$O.5128 Annual common share dividend

Source: Algonquin Power & Utilities Corp.

Operating Performance

On February 28th, 2019, Algonquin reported 4th quarter and full year results for 2018. Extending a string of impressive results, AQN reported an 8% increase in annual revenue over the same period in 2017. In the firm’s full year results for 2018, Adjusted EBITDA increased 17% and adjusted net earnings rose to $312.2 million, an increase of 39%. While adjusted net earnings per share declined by 13% in the 4th quarter, per share net earnings for the full year increased by 16%. Q4 earnings were negatively impacted by the impact of U.S. tax reform, an impact which is expected to turn positive for the company in the long run. Full year earnings were supported by dividend income from AQN’s share of Atlantica and from an impressive 58% increase in year over year revenue at Liberty Power.

Valuation

Algonquin’s valuation is a product of its rapid growth. In 2016, revenue was $823M; by 2018, revenue had more than doubled to $1.647B. Over the last 24 months, Algonquin has increased net assets by ~53%, while long term debt has only increased by <5%. Algonquin has grown revenues and assets both organically, through capital expenditures as well as through accretive acquisitions. This demonstrates that Algonquin has been able to grow the firm without using debt as the primary source of capital. This is important as it suggests that the firm has effectively utilized cash flow, equity and proceeds of DRIP to fund expansion.

Caption: AQN.TO , 10-Year Chart , Source: RBC Direct Investing

Based on Algonquin’s propensity for growth, the firm trades at a premium to other utilities providers. According to Morningstar, the industry average P/E ratio over the last 12 months is 16.36X, while Algonquin has averaged 33.76X over the last year. On a price to cash flow basis, Algonquin is currently trading at 9.61X, below its 5-year average of 11.67X. Algonquin’s current P/B is 1.85X, slightly below its 5-year average of 1.94X and the industry average of 2.05X.

While it would be difficult for the firm to continue to expand at the pace it has over the last decade, investors are correct to price in healthy growth expectations. According to Reuters, of the 14 analysts who cover the stock, one rates it a buy, seven rate rate it an outperform and six rate rate it a hold. Morningstar maintains a quantitative fair value estimate of USD $9.95, or CAD $12.96, around 10% below AQN’s current trading level. While AQN is not cheap at these levels, long-term investors can feel confident that building a position at these levels should result in capital appreciation and dividend growth, offering a compelling total return opportunity.

Source: Algonquin Power & Utilities Corp.

Risk Analysis

As a regulated utility, Algonquin would generally be considered to be a lower risk firm. The company has a healthy balance sheet and has reasonable liquidity and debt levels. In 2018, Fitch initiated coverage of Algonquin, while DRBS upgraded their credit risk rating Algonquin to BBB “with a stable trend”. As a firm that has been in a prolonged growth phase, Algonquin carries a moderate level of risk as it relates to joint ventures and acquisitions. Algonquin’s foray into the international market through its interest in AAGES and Atlantica Yield exposes the firm to international and political risk. Although the projects underway in South America seem well-conceived, operating in other jurisdictions adds a layer of complexity for the firm.

Like other dividend-paying companies, Algonquin’s share price could be negatively impacted by rising interest rates and the firm could see their cost of borrowing increase as a result of further rate increases. The firm has minimal exposure to commodity price risk and employs hedging strategies to mitigate the effect of rate fluctuation risk.

Liberty Utilities operates in 12 states and one province subjecting the firm to regulatory oversight from 13 different regulatory bodies. As Liberty operates as a regulated utility, the firm can be exposed to risks from lag in project approvals and the potential of having rate submissions rejected. Despite these risks, regulatory mechanisms help to ensure stability in revenues for Liberty Utilities and the firm employs significant resources and efforts to ensure proposed costs are included in rates. Liberty has made progress recently in decoupling revenue in 6 of 12 operating states. This decoupling effort helps to ensure that weather and seasonality-related earnings fluctuations can be offset by rate adjustments. In an effort to ensure stability, 86% of electrical output from Liberty Power is sold in long term contracts with an average duration of 14 years.

Image result for algonquin power

Source: BNN Bloomberg

Investor Takeaways

Algonquin has demonstrated an ability to grow assets and EPS through accretive acquisitions, organic growth, and capital development. As a regulated utility, Algonquin benefits from revenue stability and limited risk. AQN’s $7.5B project development portfolio will grow EPS and support dividend growth out to 2023. Dividends over the last decade have increased at a CAGR of >10% supported by 5-year CAGR EPS of >20%. The firm is currently trading near a fair valuation; however, long-term investors can expect to benefit from capital appreciation and a growing dividend.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.