Algonquin Power & Utilities: A Renewable Growth Story
Summary
- Algonquin Power & Utilities is a dual listed utility.
- The company has a split portfolio between regulated utilities and renewable energy.
- We analyze the metrics in relation to peers in both groups and give you our take.
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Algonquin Power & Utilities Corp. (NYSE:AQN) is Canada based and is in the business of generation, transmission and distribution of power to over a million customers in the Americas. Most of its business is in its home country and the US, however, it does have a presence in Chile and Bermuda too. With $15 billion in assets, it operates two business segments, the Regulated Services Group and the Renewable Energy Group.
Regulated Services Group: This segment comprises electric, natural gas, water and wastewater collection utility systems and transmission operations. Although the number of customer connections increased by around 3,000 as per last published results for 2021, the snapshot below provides a fair visual representation of this leg of the business.
Source: 2020 Annual Report
Renewable Energy Group: This segment focuses on the generation and sale of power produced by its fleet of directly owned hydroelectric, wind, solar and thermal facilities. Over 80% of the output is locked in by contractual agreements, with the weighted average term of around 13 years remaining as at end of Q1 2021. AQN also has investments in other renewable plays, which overall add another 1.1 GW of generating capacity to its roster.
Source: 2020 Annual Report
While majority of its assets are directly owned, it does have partial ownership in a couple. On March 31, 2021, the ownership structure looked like this.
Source: Q1-2021 Report
Notable is its 44.2% ownership in Atlantica Sustainable Infrastructure PLC (AY). We wrote about it for the first time recently and left feeling sufficiently impressed that now it is on our radar to "buy the dip".
Coming back to our protagonist for this piece, while AQN has done well for itself over the last 5 years, it has lagged its renewable peers.
Now, the above chart may be a bit unfair because we have thrown AQN against the pure renewable plays. AQN itself is a blend of a renewable play and a regulated utility and the next chart illustrates just how impressive its returns appear against the regulated utilities.
Let's review the numbers and see if we anticipate AQN playing catch-up to either group next.
Q1-2021
In its most recent quarter AQN delivered a 17% increase in adjusted EBITDA on the back of a 37% increase in revenues.
Source: Q1-2021 Presentation
Adjusted funds from operations (AFFO) bumped up by 15% and AQN rewarded its investors with a 10% dividend hike. Management now expects about 71 cents in annual EPS in 2021 and that is likely to move to 80 cents in 2022.
Outlook
AQN has a very aggressive plan for capital expenditures.
Source: Q1-2021 Presentation
Investors scared of aggressive expansion should take this into account. Out of the $9.4 billion in planned capex, over $1.9 billion occurred just in Q1-2021.
Source: Q1-2021 Report
The capex plans are very front-loaded with 2021 representing the peak. Management has planned for this cash outflow with the issuance of the mandatory convertible units. AQN had hinted about this a few times in the past two years. Rating agencies treat convertible equity units as 100% equity in their rating methodology, but the dilution is postponed till conversion. AQN issued units convert in 2024 when its capex plans should be winding down and all projects should be producing full strength EBITDA. Currently AQN carries nearly $7.0 billion in debt. That may sound like a lot with $900 billion of expected 2021 EBITDA. But a vast majority is at the project level ($4.5 billion). This reduces any existential risk for the company to a minimum.
Valuation
Valuation of AQN is harder than it looks. AQN is at the higher end of the traditional PE ratio metric when compared against the pure regulated utilities.
On the other hand it is relatively cheaper based on price to AFFO or dividend yield when you pitch it against the renewable plays.
AY does offer a higher yield but AQN is handily beating it in growth currently. That is AQN's non-AY parts are doing better than its AY investment. We think valuation is fair currently and AY is at the threshold of where one can get a decent return. That is mainly a commentary on the relative expensive nature of the rest of the renewable plays. We also appreciate here that AQN while perhaps modestly expensive has a very low 5 year beta.
Conclusion
We currently have a very modest renewable energy investment. As we have recently shown, the field is getting extremely crowded and that compresses margins and returns. We do own AQN which we bought on the TSX after the swoon associated with the large secondary offering. We did buy it but immediately sold the October covered calls on it. That fits with our thinking that AQN is at the investment threshold and we are happy to own it around this price and make income off the dividends and covered calls. While that may seem like a criticism, do note that we were ready to own Brookfield Renewable Energy LP. (BEP) (BEPC) only if it fell 25% lower from the current price. Investors wanting an even lower risk investment than AQN can consider the baby bonds. Algonquin Power & Utilities Corp. Fixed-to-Floating Rate Subordinated Notes - Series 2019-A due 2079 (NYSE:AQNB) pay a fixed interest at a rate of 6.20% on par till July 1, 2024, and then switches to a floating interest. Full details can be seen here.
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Disclosure: I/we have a beneficial long position in the shares of AQN, BEP, TRSWF either through stock ownership, options, or other derivatives. 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: Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.