Add Emera Inc. to the growing list of blue-chip Canadian companies suffering from a debt perception.
Much like utilities Enbridge Inc., Hydro One Ltd. and AltaGas Ltd., Emera’s shares have taken a hit this year. All four companies have completed or announced big U.S. deals. Halifax-based Emera did a US$6.5-billion acquisition of Florida’s Teco Energy Inc. in July, 2016, and its stock price has fallen 12 per cent since the deal’s closing.
The sell-off has been particularly strong in 2018, with the stock down nearly 9 per cent. Early in the year, corporate tax reform in the United States played a significant role, because there was uncertainty about its effect on Emera. In the past month, the financial impact has been clarified – Emera expects a $125-million hit to 2018 cash flow – yet investors remain cautious.
Debt remains the key reason.
Emera has tried to assuage investors for months, and last week the company held an investor day in Florida to highlight its growth potential in the Sunshine State – something analysts acknowledge is real and could help offset leverage worries. But the market’s underlying fear is that elevated debt will eventually force management to dial back its promise of increasing the company’s dividend at 8 per cent a year through 2020.
The situation is a reminder that investors’ perceptions of high-profile deals can change over time.
Initially, the Teco takeover seemed to make a lot of sense. Utilities are highly regulated, and Emera’s allowable returns on its Canadian assets hover around 9 per cent. The returns on the U.S. assets, meanwhile, come in around 11 per cent.
The deal was also announced at a time when utility stocks benefited from strong demand because interest rates were close to zero. Now that rates are rising, utilities’ dividends look relatively less attractive – putting extra pressure on Emera’s stock. (Its dividend yield is now nearly 5.3 per cent.)
“While acknowledging macro headwinds to valuations across the industry, Emera shares are trading at comparatively weak multiples given the growth outlook,” CIBC World Markets analyst Robert Catellier wrote in a recent research note.
The company’s shares now trade at a lower price-to-earnings multiple than they did before its Teco acquisition. Over the two years before the deal, they traded at an average of 17.8 times earnings; in the two years since it closed, they’ve traded at an average of 16.5 times earnings.
A large reason for this is leverage. In December, Moody’s Investors Service lowered Emera’s debt rating outlook to negative because of a “high financial risk profile,” stemming from $15-billion worth of debt at the end of September and a debt-to-rate-base ratio of about 100 per cent.
To combat this burden, Emera has raised more than $1-billion worth of equity in the past six quarters, which helped to pay down debt. In an e-mailed statement, the company also noted that its capital investment profile “includes above average growth and strong returns from our utility businesses in Florida.”
The question is whether management’s focus on repaying debt, combined with growth out of the company’s Florida assets, will be enough to keep the market happy. If not, asset sales, or slower dividend growth, may be necessary.
Some analysts are counting on asset sales.
“We believe that there is a compelling case to be made to sell assets at high valuations to both reduce leverage as well as meet ‘equity’ funding needs, particularly given relatively high M&A valuations versus Emera’s depressed stock valuation," RBC Dominion Securities analyst Robert Kwan wrote in a recent note.
Tim Kiladze