mohd izzuan
“He’s cut, the Russian’s cut, and it’s a bad cut!”
Source: Rocky IV.
Unexpected cuts can change the outcome of a contest, whether in boxing or in investing. For Algonquin Power & Utilities Corp. (NYSE:AQN), pretty much everyone who had looked at the financial statements knew the sheer inevitability of the just announced dividend cut. Sure, a small hope snuck in when it looked like Algonquin could back off its Kentucky purchase if all the stars aligned. And sure, management had said the dividend was important to investors (when do they not?). But fundamentally, we knew this was one on thin ice and designed to disappoint the dividend groupies.
Our last take was that earnings would really, really disappoint and you would get “33% off” on the dividend.
Our base case here is that AQN will make about 60 cents in earnings per share in 2023 and will be allowed to walk away from the Kentucky Power Acquisition. Earnings likely move up in 2024, but don’t cover the old dividend rate. AQN will see this and proactively cut the dividend by a third within 1-2 quarters from now.
Source: “Algonquin: Does The FERC Decision Change The Dividend Trajectory?”
The Announcement
There were 5 major points in the announcement today. We go over them and give our take on each point.
1) The company was cutting is dividend from $0.1808 to $0.1085 per common share. This is a bit worse than our base case. We are taking peanuts here for any investor looking for total returns. It happened within our timeframe, and the early announcement helps set the tone for 2023.
2) The company is going to pursue $1 billion of asset sales. This will focus on the renewable energy side of the equation. It remains to be seen whether these can be accomplished in 2023 at prices that help deleverage. When the boom was on, companies in general, and Algonquin in particular, could not get enough assets on their balance sheet.
Now, with an intense tightening cycle, everyone wants to deleverage. For every seller there needs to be a buyer, and we have doubts that the company will be able to accomplish high priced sales with risk-free rates moving up and recession risks on the horizon.
3) Algonquin will continue to pursue the Kentucky transaction, which they have to. If they did not, they would be in breach of their contract. Of course, as to what gets done to accomplish this is still unknown. Should it have to concede some ground to do so, it will likely reduce value of the transaction. The best case here is that it gets to walk away, and we hope for the shareholders that this is what happens.
4) Algonquin will be suspending its dividend reinvestment plan (“DRIP”) for its common shares. To some, this might be viewed as an excellent move here, as it is signaling that even limited dilution of equity is not acceptable at these levels. We are lukewarm on this for two reasons, though. The first is that the dividend has been meaningfully reduced, so total DRIP related dilution should be small. Remember that not all investors participate in that DRIP. The second reason here is that when you examine point number 5, well, the shares don’t look cheap. If they are not cheap, equity issuance is not exactly a problem, is it?
5) Algonquin now expects adjusted net earnings of $0.55 to $0.61 for the 2023 fiscal year. This was the centerpiece of our reason to stay out all the way down. The company only “looked” cheap if you blindly used analyst estimates. We believed they were wrong and hence the stock was not cheap. Even pre-market as we write this, consensus estimates are high as a kite.
Heck, we were the only ones who pressed on this issue, and Algonquin is now expected to come in under our forecast of 60 cents (58 cents on midpoint). We emphasize here, once again, AQN stock is not cheap at close to 12.75X earnings.
Verdict
Some uncertainty has been taken out of the equation. A lot still remains, as Algonquin Power & Utilities Corp. focuses its efforts on maintaining the investment grade rating. Asset recycling will likely prove to be an ineffective tool to blunt the interest rate pressures in 2023.
AQN stock looks cheap and has always looked cheap on the way down. 12.75X earnings just after a dividend cut is fair in our view. We have ATCO Ltd. (OTCPK:ACLLF) trading at 12x earnings with a 29-year dividend increase streak. Atco derives the majority of its earnings from regulated utilities and has a debt to EBITDA 3-4 turns lower than AQN. Sure, you will get a higher yield on Algonquin, but chasing that is what you got you here in the first place, did it not?
In the shorter term, it is anybody’s guess where Algonquin Power & Utilities Corp. stock goes. In the medium term, we expect a lot more downgrades as analysts are way offside relative to actual earnings potential. We rate Algonquin Power & Utilities Corp. stock a hold/neutral. As investors know, we reserve our sell ratings only for actual shorting, and we don’t think the current setup deserves that.
On the related securities front, Algonquin Power & Utilities Corp – Units (AQNU) continues to be a dud. This is a mandatory convertible unit and the total return should be similar to that of AQN if you calculate out to conversion.
Algonquin Power & Utilities Corp. PFD SER A (TSX:AQN.PRA:CA) listed on TSX, is an interesting issue to keep your eyes on. It is currently rated at the lowest rank of the DBRS preferred share safety scale (PFD-3L). It yields 6.4% and resets in December 2023 at 5 year Government of Canada yield plus 2.94%. At the present price of $20 CAD per share, that would work out to an 8% yield. This is an average issue, here but we might get interested under $18.00 CAD. At present there are stronger issues, like Enbridge Series P (ENB.PRP:CA), that will reset to the same yield (8%) around the same time (March 2024) and are rated two notches higher on the DBRS scale.
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.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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