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Stock to watch: Innergex may be a bargain after selloff

Innergex, which operates power projects such as Fitzimmons Creek in Whitler, has aggressive growth plans.

Innergex Renewable Energy

Innergex Renewable Energy Inc.

Last close: $9.53 a share

52-week trading range: $9.36 to $11.28 a share

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Annual dividend: 58 cents a share for a yield of 6 per cent

Analysts' ratings:
There were six buys, four holds and one sell, according to Bloomberg data. Target prices ranged from $10.50 a share, as estimated by Scotia Capital analyst Matthew Akman, to $12 a share by analysts at Desjardins Securities and TD Securities.

Recent history:
Shares of Longueuil, Que.-based Innergex tumbled to a 52-week intraday low last week just after DBRS lowered the credit rating of the renewable energy player to a non-investment-grade BB (high) from BBB (low). The stock of the developer and owner of hydroelectric plants and wind farms has bounced back a bit to reduce its loss to nearly 4 per cent (including dividends) over the past year.

DBRS said it was concerned about Innergex's "aggressive financing strategy." Its debt-to-capital ratio has reached 64.6 per cent, and the rating agency warned that its high dividend is "unsustainable" given growth plans that include seven projects totalling $812-million. The company was formed in 2010 from the takeover of Innergex Renewable Energy Inc. by Innergex Power Income Fund. The Caisse de dépôt et placement du Québec is one of its largest shareholders, having acquired a 10-per-cent stake last summer through a private placement at $10.27 a share.

Manager insight:
Innergex's stock fell about 7 per cent after the DBRS downgrade, but that "overreaction" has created a buying opportunity, suggests John Stephenson, a portfolio manager with First Asset Investment Management Inc. He believes the outlook is not negative at all.

DBRS has "misinterpreted" Innergex's financing strategy as increasing risk, Mr. Stephenson said. Like others in its industry, it obtains mainly project-level financing, which means the lender cannot go after the parent company. "If something goes horribly wrong, [the lender] only gets the assets of the power plant."

Innergex's debt is on the high side relative to many industries, but that is typical for utilities or power producers because their plant assets can have a 20-year life or longer, Mr. Stephenson said. Since the downgrade, he has been buying more Innergex shares for his funds, including First Asset Canadian Dividend Opportunity fund.

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"I am not concerned at all," he said. "What we are talking about is putting a turbine in a river, and getting an income stream that is matched with a power-purchase agreement that is typically for 20 years, but can be as long as 25. … Once you have an asset, it's pretty much a licence to print money because you have this long-term cash flow coming off it."

Mr. Stephenson notes that whereas DBRS's view is based on dividends relative to earnings, cash flow is a better comparison. The payout ratio is 100 per cent based on cash flow (after maintenance and capital expenditures) for 2013, but it is expected to start falling next year as the company's power production grows, he said.

The pullback makes Innergex more attractive, and "you are still getting 6-per-cent yield so you are being paid to wait," he said. It's in a defensive sector of the market, but unlike many utilities it plans to increase its power production within the next five years by 50 per cent, he added.

Because Innergex will need to issue some equity – likely in the second quarter – to help finance its future power plants, that "will be slightly dilutive" to its stock, Mr. Stephenson acknowledged. "But given what we have seen already in terms of a [share price] pullback, I am not expecting much."

While his one-year target is $12 a share, the average of analysts polled by Bloomberg is $11.23. Even with the consensus average, the potential return for Innergex works out to about 18 per cent excluding the dividend, he noted.

"What I like about Innergex is that it has been of our best performers for many years," he said. "It has been a consistently solid developer, and has brought on projects on time and on budget, and has sizable growth ahead of it. … It's a pure-play renewable company which is rare, and most investors will pay a premium for these companies."

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While there is a risk that investors may rotate out of defensive companies that pay a healthy yield (in favour of faster-growth, cyclical stocks), that is unlikely to happen in the near future because China's slowing economy is reducing the demand for resources, Mr. Stephenson added.

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