John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
I won't try to sugarcoat it: 2015 has been a brutal year for many of the stocks I own. Pipelines, REITs, telecoms and banks have all taken a hit, even as most of these companies have continued to raise their dividends.
Setbacks such as this are an entirely normal part of investing, so I'm staying the course.
But one of the stocks I own personally has held up exceptionally well: Even as the S&P/TSX composite index tumbled this year, Algonquin Power & Utilities Corp. posted a total return – including dividends – of 10.3 per cent through Dec. 14.
Algonquin's longer-term performance has been even more impressive. Since I first wrote about the company in December, 2012, the stock has produced a total return of more than 76 per cent, or about 21 per cent on an annual basis. That's about five times the annual total return of the S&P/TSX composite index over the same period.
As the old saying goes, past performance is no guarantee of future returns. But I believe Algonquin has a bright future. Here's why I'm continuing to hold the shares.
The business is relatively low risk
I generally avoid companies that sell a trendy product or service, because fashions come and go. Algonquin is the antithesis of that: Its 20-plus utilities distribute electricity, natural gas and water – things people use every day – to nearly half a million U.S. customers. On the power side, Algonquin generates electricity from more than 50 wind, solar, hydro and natural-gas-fired plants across North America. Because the utilities are regulated and most of the electricity is sold under long-term power-purchase agreements, Algonquin's earnings tend to be stable and predictable. What's more, with its expertise in renewable energy, the company is well-positioned to take advantage of the shift to a lower-carbon future.
The company is growing
At its recent investor day, Oakville, Ont.-based Algonquin outlined about $4.1-billion of commercially secured investments over the next five years, up from about $2.8-billion last year. "While the downturn in the oil and gas sector is causing angst about the growth outlook for energy and energy infrastructure companies, Algonquin's current business model appears unscathed," CIBC World Markets analyst Paul Lechem said in a recent note, in which he raised his 12- to 18-month price target to $11.50 from $11 (The stock closed Tuesday at $10.45). Also working in Algonquin's favour, its utilities and power operations have "virtually no commodity exposure," he said.
The dividend is climbing
Algonquin currently pays annual dividends of 38.5 cents (U.S.) a share, which – after converting the dividend to Canadian dollars – works out to a yield of about 5 per cent. That's good, but it will almost certainly get better: Algonquin has consistently raised its dividend and aims to continue growing it by about 10 per cent annually through to at least 2020, supported by projected double-digit growth in earnings and cash flow. Yet analysts expect its payout ratio – as a percentage of cash flow – to remain at less than 50 per cent, which provides a buffer for the dividend should the business hit a rough patch.
Financing needs are manageable
Algonquin's conservative payout ratio has another benefit: It means the company can recycle internally generated cash to supplement debt it takes on to finance growth, thereby reducing its reliance on equity markets. "We estimate Algonquin will need to issue roughly $700-million [Canadian] in common equity over the next five years, which is very manageable, in our view," RBC Dominion Securities analyst Nelson Ng said in a recent report. Earlier this month, the company raised $150-million in a bought deal to support its 2016 growth plans. Another plus: Algonquin has the backing of Halifax-based Emera Inc., which owns roughly a one-fifth stake.
The shares are reasonably priced
Algonquin trades at a multiple of about 10 times EV/EBITDA (enterprise value to earnings before interest, taxes, depreciation and amortization) based on 2016 estimates – a discount to the average EV/EBITDA multiple of about 11 for similar companies, analyst Bill Cabel of Desjardins Securities Inc. said in a note. Based on Algonquin's growth – including the announcement of the new Great Bay solar project in Maryland – Mr. Cabel raised his price target on Algonquin to $12 (from $11.75), which would bring its valuation in line with its peers.
Final thoughts
Algonquin is on the conservative end of the spectrum, but no stock is risk-free. RBC's Mr. Ng cites several factors that could hurt the shares, including a significant increase in long-term interest rates, unfavourable regulatory decisions, a weaker U.S. dollar and depressed power prices in the U.S. Northeast. Do your own due diligence before investing in any security and always diversify to control your risk.
