If you believe in Warren Buffett’s advice to be greedy when others are fearful, you might consider putting a few beaten-down utilities and power producers on your shopping list.
Thanks to the regulated returns of utilities and the long-term contracts under which power producers sell much of their electricity, these companies enjoy relatively predictable cash flows. That stability, in turn, allows them to pay dividends that often grow over time, making them a favourite of income-seeking investors.
But utilities and power producers have one major weakness: Because they typically carry debt to finance their operations, and because their cash flows are somewhat bond-like, their share prices are vulnerable to rising interest rates.
With the 10-year Government of Canada bond yield gaining nearly a full percentage point since last June, power and utility stocks have been plunging. Through April 27, the group was down an average of about 8 per cent this year, excluding dividends – roughly double the drop of the S&P/TSX Composite Index.
This is where being greedy could pay off, according to analysts who say the selloff in the sector has gone too far.
“While this negative relationship between rates and sector valuations appears to be a fact of life, we also believe it has led to some material mispricing situations and has overshadowed several important catalysts,” David Quezada of Raymond James said in a recent note.
“While we are hesitant to make a call on when the interest rate environment will shift, we believe several names in the space either feature growth rates that largely offset a rising rate environment or valuations that fully reflect steadily rising rates.”
Here are three stocks that Mr. Quezada and other analysts find especially attractive.
Boralex Inc. (BLX)
Yield: 2.6 per cent
With operations in Canada, the United States and France, independent power producer Boralex generates about 85 per cent of its output from wind, with smaller contributions from hydroelectric, thermal and solar. Already a dominant player in France’s onshore wind sector, the company recently bolstered its position in that country with the $202-million (plus assumed debt) purchase of Kallista Energy Investment SAS, which added 163 MW of generation, boosting Boralex’s total capacity to 1,619 MW. Given the company’s robust pipeline of projects in Europe and Canada, reaching its internal target of 2,000 MW by 2020 is “highly achievable,” Mr. Quezada said. Yet the stock price – which he estimated could be worth $30 or more if the target is met – is currently not reflecting Boralex’s future growth potential, he said. Boralex’s yield is modest, but the dividend has grown at an annualized rate of 7.4 per cent over the past two years.
Algonquin Power & Utilities Corp. (AQN)
Yield: 4.8 per cent
Mr. Quezada calls Algonquin, whose shares have skidded about 13 per cent from their December high, “one of the most undervalued stocks in our coverage universe.” The company, which owns renewable power and utility assets in North America and has recently expanded abroad, now trades at the low end of its forward price-to-earnings multiple range of 17 to 25 for the past five years, representing “compelling value at current levels,” he said. The company, which aims to increase its dividend at an annualized rate of 10 per cent, recently increased its stake in London-based Atlantica Yield PLC to 41.5 per cent, up from its initial purchase of 25 per cent in November, accelerating Algonquin’s international growth. “We remain excited about the potential of the international development strategy,” analyst Bill Cabel of Desjardins Securities said in a recent note, adding that Algonquin “has the potential to deliver strong, sector-leading returns, and it remains one of our preferred names.”
Northland Power Inc. (NPI)
Yield: 5.2 per cent
Northland Power operates wind farms (about 50 per cent of estimated 2018 generating capacity), gas and biomass plants (45 per cent) and solar facilities (5 per cent). Offshore wind is a key driver of growth: The company has two projects in the North Sea that came into service last year, with a third expected to begin operations by the end of 2019. This week, the government of Taiwan selected Northland’s 300 MW Hai Long 2 offshore wind project – in which the company has a 60-per-cent interest – to provide power to the country’s electricity grid. Assuming the necessary permits and approvals are received, the project is expected to begin commercial operation by 2024. According to analyst Jeremy Rosenfield of Industrial Alliance Securities, Hai Long 2 will generate net free cash flow of more than $25-million a year – worth about $1 a share on a discounted cash flow basis – and marks “a strategic first step in Taiwan’s burgeoning offshore wind market. We believe that [Northland] has the potential to secure contracts for additional capacity in Taiwan via upcoming competitive tenders.”
Disclosure: The author owns shares of AQN personally and in his Yield Hog Model Dividend Growth Portfolio. View it at tgam.ca/dividendportfolio.