Author’s note: All currency figures listed in USD unless otherwise noted.
Since I last wrote about Algonquin Power & Utilities Corp. (AQN) in May 2019, the stock has returned approximately 57%. Despite the strong performance, this company remains well positioned for growth. Algonquin is advancing a five-year $9.2B capital investment program across its regulated utilities and renewables businesses. This capital program will grow the firm’s asset base to approximately $17B and enhance Algonquin’s stable recurring revenue. Algonquin provides exposure to the fast-growing renewables market while being buoyed by a robust core business of regulated utilities. A high portion of regulated earnings has enabled Algonquin to increase its dividend for the last nine consecutive years at an average annual rate of 10%. This high-quality company combines dividend income and capital appreciation in one single regulated utility earning it a top-ten position in my portfolio.
Algonquin is a diversified generation, transmission, and distribution utility with core operations in 13 U.S. states and one Canadian province. The company operates through its two principal subsidiaries: Liberty Utilities and Liberty Power. Liberty Utilities is a provider of regulated natural gas, water and electricity generation, transmission and distribution utility services to over 800,000 customers in North America. Liberty Power produces 2.2GW of clean energy through its diverse portfolio of wind, solar, hydro, and thermal assets. Algonquin has recently closed acquisitions in Chile and Bermuda expanding its global footprint and adding to its sizable global presence owned through its interest in Atlantica Sustainable Infrastructure PLC (NASDAQ:AY).
With a market capitalization of approximately $9.3B, Algonquin Power & Utilities Corp. trades on both the Toronto Stock Exchange and the New York Stock Exchange under the symbol “AQN”. Daily average volume is approximately 700,000 in New York and 2.4M in Toronto. While the company is domiciled in Ontario, Canada, Algonquin reports its results and pays its dividends in $U.S. In June 2020, Algonquin was added to the S&P TSX 60 index, Canada’s main large-cap index. This inclusion will increase demand for shares and will broaden the passive ownership of the company. Enhanced demand for shares should support future equity offerings giving Algonquin more scope to pursue capital-funding sources.
Source: APUC Investor Presentation
According to Bloomberg New Energy Finance, over the next 30 years, $300B is expected to flow into new renewable energy assets annually. The renewable energy industry has reached an inflection point driven by public demand for decarbonization and advancements in technology that have lowered the costs of renewable energy. Increasing demand for renewable energy and a growing appetite among institutional investors for socially responsible assets are both dominant trends that ensure a bright future for Algonquin.
Joe Biden’s recent win of the U.S. presidential election will result in additional support for green infrastructure spending. Biden’s plans for infrastructure spending will include a focus on the creation of a green energy grid in the U.S. by 2035 and an emphasis on clean energy research and development. This spending will provide additional near- and medium-term tailwinds for renewable energy companies such as Algonquin.
Atlantica Sustainable Infrastructure Interest
In addition to its operating primary operating brands, Liberty Power and Liberty Utilities, Algonquin also holds a 44.2% controlling interest in Atlantica Sustainable Infrastructure, formerly Atlantica Yield PLC. At current market prices, this equity position in the global renewable power operators is worth $1.52B, or approximately 16% of Algonquin’s market capitalization. This position in AY represents a substantial portion of Algonquin’s exposure to renewables. Atlantica is more geographically diversified than the rest of Algonquin’s operations with 41% of its operations in Europe, 36% in North America and 12% in South America.
Atlantica offers Algonquin a steady and predictable source of cash through its long-term power purchase agreements. As of December 2019, its average remaining contract life was approximately 18 years. In 2019, Algonquin’s interest in Atlantica and other equity investments generated in excess of $100M in dividends and interest. This revenue provides Algonquin significant optionality to direct funds to capital or operational priorities creating financial flexibility for the company.
Algonquin is currently advancing a massive $9.2B five-year capital program; the largest in the company’s history. 72% of this investment will be directed to regulated utility projects while the remaining 28% will be used to grow Algonquin’s renewable energy portfolio. By 2024, Algonquin will have shifted its regional revenue sources to take advantage of renewables opportunities in Texas, Western Canada and California. In the company’s last quarterly update, Algonquin announced that the company remains committed to the capital plan despite COVID-19. Through the execution of its capital plan, Algonquin anticipates 15% CAGR in EBITDA from 2019 to 2024. The majority of this new EBITDA will be derived from the company’s regulated utility business. Algonquin aims to maintain its current revenue mix of approximately 1/3 renewables and 2/3 regulated utilities.
Over the five-year capital program, the most capital-intensive period is scheduled to take place between 2021 and 2022 when some of the larger projects such as the $600M Maverick Creek, Texas, wind farm and the $500M Neosho Ridge, Kansas, power line will be under construction. A noteworthy focus of this capital plan is its focus on commercial and industrial growth opportunities. Algonquin is well positioned to support the transition of other companies as they respond to ESG pressure to decarbonize. According to Algonquin CEO Arun Banskota:
As I look forward at the changing energy market, I believe that commercial and industrial, C&I business segment will represent an enormous channel for growth. Today, it accounts for the majority of energy consumption, in fact, more than transport and residential commercial combined. And the vast majority of industrial consumption is fossil fuels, petroleum, coal and natural gas.
Recent examples of Algonquin’s positioning in this space include recent power purchase agreements with General Mills, Inc. (NYSE:GIS) and Kimberly-Clark Corporation (NYSE:KMB) to supply production facilities with wind power in Texas. Similarly, Algonquin announced a recent 500MW four-year deal with Chevron Corporation (NYSE:CVX) to co-develop renewable power projects to assets across Chevron’s global portfolio. With construction set to begin in 2021, these projects will be focused on supplying Chevron’s operations in the U.S. Permian Basin, Argentina, Kazakhstan and Western Australia with clean power. In this deal, Chevron has committed to purchase electricity from the jointly owned generation assets through power purchase agreements.
Source: APUC Investor Presentation
Algonquin has caught the attention of institutional investors with its ambitious capital program. In 11 of the past 12 quarters, Algonquin has seen net positive buying from institutional investors. In July, Hedge fund Zimmer Partners LP bought 1,000,000 shares of AQN for $13.5M. Zimmer Partners is one of 14 hedge funds that have built positions in Algonquin in recent years. This interest from institutional investors stems from a desire to access infrastructure assets, renewable power generation assets, and stable cash flows.
Attention from institutional investors has supported Algonquin’s capital program by providing buyers for recent equity offerings. On July 17th 2020, Algonquin completed an offering of common shares that raised CAD983M. This deal included an oversubscribed bought deal offering of CAD633M and a concurrent offering of CAD350M to an institutional investor.
Algonquin pays a quarterly dividend of $0.1551 per share for an annual payout of $0.6204 per share. With a current yield of approximately 3.93%, shares are currently yielding below the company’s five-year average of 4.36%. The most recent dividend increase in May 2020 was a 10% bump from the prior dividend of $0.1410. This last increase marked the ninth consecutive annual increase with a growth rate averaging 10% over the last decade. This rapid and predictable dividend growth rate is underpinned by strong EPS growth of 9-10% in recent years.
Source: APUC Investor Presentation
Going forward, Algonquin forecasts EPS growth of 9-11% annually to 2024 supporting continued dividend growth. Despite this strong record of dividend growth, Algonquin has continued a trend of declining dividend payout ratio. The current ratio of 59.6% permits the company significant flexibility to continue to grow its dividend. At Algonquin’s most recent investor day, the company reiterated its commitment to grow the dividend 10% annually through 2021 with plans to evaluate future commitments based on the payout ratio.
When compared to its peers, Algonquin is a clear leader in dividend growth outperforming both short-term and long-term dividend growth rates.
Source: Graph Author, Data from Canadian Dividend All-Star List
While Algonquin is headquartered in Canada, it pays its dividends in U.S. currency, which can be especially attractive for Canadian investors. Algonquin Power & Utilities investors can also take advantage of the company’s dividend reinvestment program that offers a 5% discount on reinvested dividends. Investors can enroll in the share repurchase program or take advantage of a synthetic DRIP with some brokerages. This discounted reinvestment plan is a great option for long-term shareholders interested in amassing discounted shares for future income needs.
Algonquin’s strong year-to-date share price performance has left the company fully valued at current levels. Algonquin is currently trading at forward P/E of 21.6X, ahead of its five-year average forward P/E multiple of 19.36X. This valuation is expensive compared to peers Fortis (NYSE:FTS) with a forward P/E of 19.1X and Emera Incorporated (OTCPK:EMRAF) with 18.2X. On a cash flow basis, the company is trading at 14.7X cash flow, a significant premium to Algonquin’s five-year average of 11.29X. Investors initiating new positions can wait for a better entry point.
Impact of COVID-19
Shares of Algonquin have performed well during the pandemic with COVID-19-related shutdowns having only a minor impact on the business. The renewables segment has been largely insulated from any negative effects due to its long-term power purchase agreements with creditworthy counterparties and operations that lend themselves well to physical distancing. The utilities business meanwhile has experienced some decline in demand. On Algonquin’s Q2 2020 earnings call, CEO Arun Banskota shared that moderate decreases in demand in some of the company’s utilities amounted to just over $0.01 on a per share basis.
The larger impact of COVID-19 could be on Algonquin’s ability to execute its capital plan. Banskota reaffirmed the company’s commitment to the Algonquin’s capital plan stating, “The total growth thesis has not been impacted by the challenges currently being experienced due to COVID-19.” Many of the company’s construction projects have been determined to be critical infrastructure in their respective jurisdictions, which has allowed the majority of construction to continue.
As Algonquin operates across many states and countries, its geographic diversification blunts the negative impact of any particular economic or regulatory challenge in a particular region. Algonquin’s capital program is also geographically diversified which serves to distribute the regulatory risk of project approvals across jurisdictions.
Algonquin has a long history of growing through acquisitions, having completed 27 utilities since 2009. While this strategy has been tremendously successful for the company, there is a risk that Algonquin could overpay for an asset. Algonquin’s record of acquisitions has been positive, with last year’s acquisitions of New York American Water expected to be 1% accretive to EPS over the next five years and its recent acquisition of Bermuda Electric Light Company will be immediately accretive to 2021 EPS.
Despite the company’s propensity to pursue an aggressive strategy of organic and acquisitional growth, Algonquin remains highly committed to maintaining its investment-grade credit rating. The company and its subsidiaries currently have a BBB credit rating from Fitch, S&P and DBRS Morningstar. In January 2020, DBRS Morningstar reaffirmed the stable trend for Algonquin’s principal subsidiaries Liberty Utilities and Liberty Power. Algonquin has maintained a stable capital structure of approximately 45% debt, 45% equity and 10% preferred shares even as the company continues to expand its operations. Similarly, the company has kept a narrow range on its FFO/Debt metrics ranging between 14% and 16% in recent years despite making some large acquisitions such as the New York American Water transaction for $608M in 2019.
Algonquin combines the stability of a regulated utility with an ambitious growth strategy. The company is pursuing broad-based growth through its $9.2B capital plan as well as through opportunistic acquisitions. Algonquin offers investors a clear line of sight to strong EPS growth in a sector that is supported by secular tailwinds. This company is a top ten holding of mine due to its sector-leading dividend growth and its potential for long-term capital appreciation. While the company is fully valued at current levels, I continue to add to my position on pullbacks.
Disclosure: I am/we are long AQN. 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.