Two years ago, I moved money into Algonquin Power & Utilities Corp. At first, the stock did exceptionally well, but over the past nine months it has been tanking and I’m concerned. Can you shed any light on what’s happening?
Several readers have expressed concern about Algonquin (AQN). Today, I’ll explain why the shares have fallen and why investors with a long-term focus needn’t worry. (Disclosure: I own the shares personally and in my model Yield Hog Dividend Growth Portfolio.)
To begin, let’s put the recent drop in perspective. For the 12 months through Nov. 18, Algonquin’s share price is down about 11.6 per cent. Including dividends, the total return was negative 7.9 per cent. That’s not great, but it hardly qualifies as “tanking.”
Consider, too, that even after the recent slide, Algonquin still posted an annualized total return of 15.9 per cent over the past five years. One of the points I stress in my columns is that investing is a long game, and investors who want to generate wealth must learn to live with short-term volatility.
But it’s reasonable to ask why Algonquin’s shares have been struggling even as other utility stocks have held up relatively well.
First, Algonquin is not a pure utility. In addition to its regulated utility operations, which deliver electricity, natural gas and water primarily to U.S. customers, the company owns a largely North American portfolio of non-regulated hydro, solar and wind facilities whose electricity is sold mainly under long-term contracts.
Last year, in the months before and after the U.S. presidential election, renewable power stocks soared in response to Joe Biden’s proposals to invest hundreds of billions of dollars in clean energy. But valuations in the sector got too high, and as the frenzy waned shares of renewable generators, including Algonquin, fell. It probably hasn’t helped that Algonquin’s renewable generation has been below expectations recently, reflecting weaker-than-average wind resources.
A second reason for the stock’s weakness was Algonquin’s agreement, announced on Oct. 26, to acquire Kentucky Power Co. and AEP Kentucky Transmission Co. from American Electric Power Co. Inc. (AEP) for about US$2.85-billion, including debt. As part of the financing, Algonquin announced an $800-million bought deal of shares priced at $18.15 each, which was 1.9 per cent below the stock’s market price before the deal was announced. The discount – which is common with bought deals – helps to explain why the stock fell when trading opened the next day.
Uncertainties about integrating the acquisition, and securing all of the remaining financing, may have also weighed on the stock. The fact that Kentucky Power’s earnings have been under pressure for years, in part because of the region’s weak economy, was likely another factor in the market’s cool reception to the deal.
But the Kentucky Power acquisition also creates long-term opportunities, analysts say.
“We believe this acquisition ticks the important boxes including a reasonable valuation, solid earnings accretion, optimization potential, and the opportunity for AQN to utilize its ‘greening the fleet’ capabilities,” David Quezada, an analyst with Raymond James, said in a recent note. He reiterated his “outperform” rating on the shares and raised his price target to $20 from $19. The shares closed Friday at $17.96.
One of Algonquin’s first objectives will be to improve Kentucky Power’s earnings, which in recent years have fallen short of the returns allowed by regulators. “Algonquin has a history of acquiring non-core assets from larger utilities and improving returns,” Nelson Ng, an analyst with RBC Dominion Securities, said in a note.
Over the longer term, Algonquin also has a substantial opportunity to replace the coal-fired generation that accounts for a majority of Kentucky Power’s electricity output. Investments in solar and wind generation will add to Kentucky Power’s rate base – the value of assets on which a utility is allowed to earn a regulated return – which in turn will contribute to Algonquin’s earnings growth.
Even without the Kentucky Power acquisition, Algonquin has plenty of growth ahead. The company’s $9.4-billion capital plan for 2021 to 2025 includes about $6.3-billion of investments in regulated utilities and $3.1-billion in renewable power, which will help to drive the company’s projected annual growth of 8 per cent to 10 per cent in earnings per share. These investments will also support continued dividend growth, although likely at a slower pace than the 10-per-cent annual increases of recent years, analysts say. Algonquin is expected to update its growth outlook at its annual investor day on Dec. 14.
As bright as Algonquin’s future may be, it’s anyone’s guess how the shares will perform in the short run. Should interest rates rise sharply, for example, the share price could remain under pressure. But Algonquin’s above-average dividend yield of 4.8 per cent, and its attractive valuation, could help to limit the downside. After the recent pullback, the shares trade toward the lower end of their historical price-to-earnings range and below the P/E multiples of other regulated utilities including Fortis Inc. (FTS) and Emera Inc. (EMA), Mr. Quezada said. That could make Algonquin’s shares attractive to prospective purchasers.
Instead of worrying about Algonquin’s share price, my advice is to collect your dividends – and focus on the solid long-term returns the company will likely continue to generate.
E-mail your questions to firstname.lastname@example.org. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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