Algonquin's Outlook Continues To Be Favorable

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About: Algonquin Power & Utilities Corp. (AQN), Includes: FTS
by: Ploutos Investing
Summary

Algonquin Power & Utilities Corp. owns and operates a diversified power and utilities assets in North America and several international markets.

The company has a healthy development pipeline that should support its double-digit EBITDA growth rate through 2023.

Algonquin pays a growing dividend with a dividend yield of about 4.3%.

Investment Thesis

Algonquin Power & Utilities Corp. (AQN) (TSX:AQN) delivered an in line quarter in Q1 2019. Looking forward, the company has an ambitious US$7.5 billion capital program that should help support its double-digit EBITDA growth rates through 2023. The company also has an excellent track record of dividend growth in the past. We expect this growth rate to continue as it grow its bottom line. However, shares of Algonquin are not trading at a discount. Nevertheless, its shares should continue to do well in the long-term. We think any pullback will provide good entry opportunity.

Data by YCharts

Recent Developments: Q1 2019 Highlights

Algonquin reported Q1 2019 results with slightly lower revenue than Q1 2018. This was primarily due to lower renewable power generations in Q1 2019 while Q1 2018's power generations were above average. Its adjusted EBITDA also fell significantly by 17% year over year to US$231.5 million. In addition to below average renewable power generations, its adjusted EBITDA was impacted by the one-time Tax Reform adjustment in Q1 2018. Without this one-time adjustment of US$55.9 million, Algonquin's adjusted EBITDA would have increased by US$7.8 million year over year.

Source: Q1 2019 Earnings Presentation

Bermuda Electric acquisition is a plus

In early June, Algonquin announced to acquire The Bermuda Electric Light Company ("BELCO") for US$365 million. This Bermuda based company provides electric utility services to the country's 63,000 residents and businesses. The acquisition price represents an EV to EBITDA ratio of about 7.3x of BELCO's 2020 EBITDA. This is much lower than Algonquin's EV/EBITDA ratio of 11.9x. BELCO's lower valuation is likely due to the fact that the island's population is expected to decline by 5,000 by 2025. This is a small tuck-in acquisition and we do not think that it will have a material impact on Algonquin's valuation.

Earnings and Growth Analysis

We continue to like Algonquin's outlook for the following reasons:

A rich development pipeline in renewable energy projects

Algonquin has a portfolio of 39 renewable power generation facilities in North America. These 1.5 GW power generation facilities has 14 years of average power purchase agreements. We like the fact that 86% of its power capacity is protected with inflation escalators. This means that their revenue received will be able to keep up with inflation. This will also support its future dividend growth. In addition, management expects to invest about US$1.7 billion in several renewable energy projects in the next five years. This should increase its power generation capacity and grow its top and bottom lines.

Source: May 2019 Investor Presentation

Significant international growth opportunities through AAGES joint venture

Algonquin has significant growth opportunities in the global market through its AAGES joint venture. The company has recently won a bid on an 80 KM transmission development project (about US$80 million) in Uruguay with a long-term lease agreement of 30 years with inflation indexation. Looking forward, Algonquin expects to focus its investment in the following segments: Desalination, wastewater and water treatment, and electric transmission.

Source: May 2019 Investor Presentation

An investment grade balance sheet to support its 5-Year US$7.5 billion of capital program

Algonquin has an investment grade balance sheet with BBB credit rating by S&P, DBRS, and Fitch. Its long-term debt of US$3.03 billion consists about 41% of its total capitalization. This balance sheet should allow it to pursue its goal of US$7.5 billion of projects in the next five years. As can be seen from the pie chart in the bottom left, the company plans to raise the capital through a combination of debt, hybrid debt, dividend reinvestment plan, free cash flow, and equity issuances. As can be seen from the pie chart in the bottom right, the capital is expected to be used in its three segments: Liberty Utilities (its utilities segment in North America), Liberty Power (renewable power segment in North America), and International segment. The company expects to deploy about US$5.3 billion in its utilities segment, US$1.7 billion in its renewable energy segment, and US$0.5 billion in its international segment.

Source: May 2019 Investor Presentation

Risks and Challenges

Acquisition risk

Algonquin has grown to its current scale through a combination of organic growth and acquisitions. We expect a large portion of its future acquisitions will be outside of North America, and perhaps in areas and territories management may not be familiar with. Therefore, there may be integration risks.

Development risk

There may be delays to any of its projects as many of its projects require approvals and permits from different levels of governments. Its projects may also be delayed due to shortage of workers as unemployment rates in Canada and United States remain very low. Any delays may negatively impact its current plan to grow its adjusted EBITDA by over 10% through 2023.

Valuation Analysis

Algonquin is currently trading at an EV to EBITDA ratio of 12.6x. This is the highest we have seen since the beginning of 2018. Its valuation is also comparable to Fortis' (FTS) 12.6x. Like many other utilities, Algonquin's share price has increased significantly by 19%. We think this is due to the fact that investors are rotating funds towards defensive sectors as there is a fear of a recession. We do not see any reversal anytime soon, but recognize that its shares are currently not cheap due to this sector rotation in the stock market.

Data by YCharts

A growing 4.3%-yielding dividend

Algonquin has recently increased its quarterly dividend by about 10%. It currently pays a quarterly dividend of US$0.141 per share. This is equivalent to a dividend yield of about 4.3% as of June 5, 2019. As can be seen from the chart below, Algonquin has an excellent track record of dividend growth in the past few years. We expect it continue to grow its dividend in the same pace in the next few years.

Data by YCharts

Investor Takeaway

We like Algonquin and its growth outlook. The company's expansion into other international markets should also provide a long runway of growth. It has a good track record of dividend growth and we expect it to continue the pace of dividend growth in the next few years. We consider this stock as a core long-term holding for dividend growth investors. However, its shares are not cheap right now. We recommend adding shares on any weaknesses.

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.

Additional disclosure: Additional Disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.