John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
I've said it many times before: Buying solid companies when their stocks have tumbled on short-term worries is a sound way to build long-term wealth.
In February, for instance, I wrote that the sell-off in utility operator Fortis Inc. – which had recently announced the acquisition of U.S.-based ITC Holdings Corp. – represented a buying opportunity. Since that column appeared, Fortis's shares have rebounded by more than 7 per cent.
Well, Fortis wasn't the only Canadian-based utility owner to announce a U.S. acquisition in February. On the same day as the Fortis-ITC deal, Oakville, Ont.-based Algonquin Power & Utilities Corp. unveiled plans to acquire Empire District Electric Co. of Joplin, Mo., for $2.4-billion (U.S.), including assumed debt.
And guess what: Algonquin's stock also skidded on the news. Analyst Paul Lechem of CIBC World Markets chalked it up to two factors: the "short-term overhang" of Algonquin's $1-billion (Canadian) – later increased to $1.15-billion – issue of convertible debentures, which pay interest at 5 per cent and are convertible into Algonquin shares at $10.60 each, and the usual risks surrounding the required regulatory and shareholder approvals.
In recent weeks, Algonquin's shares have been recovering as investors look past the short-term uncertainties and focus on the deal's many benefits. As an Algonquin shareholder, I'm not fazed by the drop in the stock; over the longer run I believe that the acquisition – which is expected to close in the first quarter of 2017 – will benefit Algonquin in several ways.
After all, making acquisitions is one of Algonquin's strengths.
The company – whose current business consists largely of non-regulated renewable power generation assets and regulated utilities – already provides electricity, gas or water to about 560,000 customers in about 10 U.S. states through its Liberty Utilities subsidiary. The Empire acquisition will significantly expand Liberty Utilities' scale, adding about 218,000 electric, gas and water customers in Missouri, Kansas, Oklahoma and Arkansas. (Liberty Utilities is already familiar with Missouri and Arkansas, having operated there for many years.)
Because virtually all of Empire's assets are regulated, the deal will boost the proportion of Algonquin's regulated earnings to about 72 per cent of EBITDA (earnings before interest, taxes, depreciation and amortization) from about 51 per cent currently, the company said. This is a plus for shareholders who want predictable, low-risk returns.
What's more, Algonquin expects that the deal will boost earnings per share by an average of 7 to 9 per cent annually in the three years following closing, with funds from operations a share (a measure of cash flow) rising 12 to 14 per cent annually over the same period. That's good news for investors who are counting on Algonquin's regular dividend increases to continue. "The transaction will provide additional support to [Algonquin's] annual dividend growth target of 10 per cent," the company said.
It might even do better than that.
Citing "the potential for accelerated dividend growth" thanks to the expected boost to earnings and cash flow from the Empire deal, CIBC's Mr. Lechem raised his 12- to 18-month price target on Algonquin to $13 from $12 and reiterated his "sector outperformer" rating. The shares closed yesterday at $10.91, up 1 cent, on the Toronto Stock Exchange.
Although the $10.60 conversion price of the debentures and the potential "flowback" of Algonquin shares onto the market following conversion "might provide short-term headwinds to the stock, we see continued long-term growth and view the current sell-off as providing an attractive entry point on the stock," Mr. Lechem said.
He's not alone in that view. Of the eight analysts who follow Algonquin, all eight rate the company a "buy" or equivalent, according to Bloomberg. The average price target on the stock is $13.04.
While bullish analyst recommendations are no guarantee that an investment will pan out, Algonquin's growing exposure to low-risk utilities, rising dividend and appetite for acquisitions provide a nice combination of defence and offence. That's why I'm focusing on the long term and not worrying about the stock's recent pullback.