Algonquin Stock: Dividend Growth Slows and Debt Risks Rise (NYSE:AQN)

Huntsville and Highway 60 to Algonquin Park in Fall, Ontario, Canada

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Last time we covered Algonquin Power & Utilities Corporation (NYSE: AQN) we gave it a bullish rating. This was despite the fact that we expected a much slower dividend growth rate than the market was accustomed to.

Net debt to EBITDA, which includes many project-specific and non-recourse debt, is still near the 7.5X mark. over time, which will likely require less dividend growth. Our fair value here is about $15.50/share on the US exchange and that’s about $20 on the TSX.

Source: Expect dividend growth to slow significantly

That’s about as clear as it gets.

The stock has been roughly flat since then, but has underperformed the Utilities sector (XLU) and outperformed the broader market.

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Data by YCharts

The company recently released its first quarter 2022 results and we decided to see if our thesis of a slowdown in dividends plays out as expected.

Q1-2022

Earnings came in where analysts expected 21 cents per share while adjusted EBITDA was a bit weaker at $330.6 million. AQN delivered strong volumes in the regulated and renewable segments, but prices seemed a bit off and as a result the numbers were a little lower than expected. The company reiterated that it expects the Kentucky Power acquisition to close shortly when the last of the pending approvals is obtained. These are FERC and West Virginia approvals.

The company declared a 6% increase in dividends at an annual rate of $0.7233. It was a bit mixed compared to our expectations. On the one hand, yes, we are finally leaving double-digit growth behind us as expected. On the other hand, we would have preferred a more marked slowdown to preserve our liquidity. Since we are forecasting around $0.73 to $0.74 in revenue, the payout ratio now jumps to almost 100%. There is little wiggle room here.

Outlook

AQN has certainly had great results over the past few years and the dividend growth story has been fantastic. At this point, we think AQN is slightly more ambitious than the financial markets allow. For example, it plans to spend nearly $12.5 billion over the next 5 years.

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(AQN presentation Q1-2022)

Obviously, with a close to 100% payout ratio, this is almost entirely funded by the capital market. For the Kentucky acquisition, AQN has been pre-funded and is unlikely to hit the capital markets in 2022. But beyond that, we see huge funding needs, every year. Now utilities do, and so do REITs. We just think AQN’s debt to EBITDA is getting too high. Here we see exit debt to EBITDA close to 8.0X (estimate range 7.7X-8.0X). Much of it is surrounded by assets and these assets, generating renewable energy, are becoming increasingly valuable. We are therefore not adopting an extremely bearish view here, but simply emphasizing that it becomes risky even for good assets. We would have preferred a further downturn in dividends, but management likely weighed the crowd impact of the DRIP. The longer they keep them, the better it is for equity financing.

Evaluation and verdict

AQN has been difficult to assess with its mix of assets. We have half of the renewable energy production assets and the other half with a regulated structure. It sits midway between a company like Brookfield Renewable Energy (BEP) (BEPC) and companies like Emera Inc. (OTCPK:EMRAF) on the one hand and Fortis Inc. (FTS) on the other. All unfortunately have high debt levels, but we still consider AQN to have the least flexibility in this group. Yes, BEP has higher debt, but its unsecured credit rating is in a different league.

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Data by YCharts

AQN’s dividend is an attractive point here, especially in relation to this group.

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Data by YCharts

AQN’s actual futures yield is even higher because the new data hasn’t flowed to the Y charts. So AQN is paying you to be involved here, but it comes at the cost of leverage ratios and dangerously high payouts. At this point, given the dangers we see for the utilities sector, and for high yield in general, we are downgrading this to a hold/neutral. We currently own the stock, but have sold in-the-money calls. We expect the stock to be recalled, barring a decent drop. Our favorite game in the industry comes from TransAlta Corporation (TAC) which controls TransAlta Renewables (OTCPK:TRSWF). TAC trades at nearly half of AQN’s EV/EBITDA multiple. The renewable generation side is very similar to that of AQN, maybe better. But instead of a regulated utility side, it has an unregulated power generation side. We think this combination is actually better and at half the valuation and less than half debt to EBITDA, we prefer that.

Please note that this is not financial advice. It may seem, seem, but surprisingly, it is not. Investors are required to do their own due diligence and consult a professional who knows their objectives and constraints.