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Algonquin Power & Utilities Corp.’s Riviere-du-Loup hydroelectric generating facility in Quebec.

After Arun Banskota delivered Algonquin Power & Utilities Corp.’s AQN-T first-quarter results on May 11, the chief executive officer faced far more scrutiny over the company’s green future than its recent financial performance.

Algonquin for years had combined three attributes that made it a popular stock with investors: strong growth from delivering regulated electricity, water and natural gas; clean power generation from wind, solar and hydroelectricity; and a consistently rising dividend with a fat yield that rivalled banks.

But the previous six months had marked a difficult period for the company. Rising interest rates and changes to U.S. tax credits weighed on profits in last year’s third quarter and walloped the share price – raising questions about the company’s growth outlook, bloated debt levels and investment-grade credit rating.

In January, Algonquin slashed its dividend by 40 per cent. In April, it terminated a deal to acquire Kentucky Power Co., once seen as a key to U.S. expansion.

The biggest decision, by far, is still coming: Algonquin announced in May that it may sell its renewable power business and become a stand-alone regulated utility.

“Given the societal move toward decarbonization and energy transition, when we look at our regulated business and our renewables business, we see unlimited opportunities,” Mr. Banskota said on a call with analysts.

“But we believe our assets are undervalued.”

Selling the clean-energy business – which accounts for about 20 per cent of Algonquin’s asset base – would follow similar sales earlier this year by Duke Energy Corp. and American Electric Power Co. Inc., two U.S. utilities, putting additional pressure on Algonquin to follow suit.

The decision on whether or not to pursue a sale, Mr. Banskota said, will be announced in August when the company reports its second-quarter financial results.

Already, though, the pressure to carve up Algonquin is emerging from activist investors and analysts, who argue that significant changes are necessary to reduce the company’s debt, bolster its credit rating, simplify its structure and restore credibility in the stock market.

Starboard Value LP – an activist hedge fund that owns more than 5 per cent of Algonquin’s outstanding shares, making it the second-largest shareholder – outlined in a July 6 letter to Algonquin’s board that the company’s high debt levels and recent dividend cut make the stock “uninvestible” for most utility investors.

Selling the renewables, it believes, will allow the company to reduce debt, buy back shares and boost profitability, rewarding shareholders.

“Algonquin would become, what we view as, a best-in-class mid-sized utility,” Jeffrey Smith, managing member of Starboard Value, said in the letter.

Algonquin declined The Globe and Mail’s request for comment. Starboard did not respond.

Like Starboard, Cleveland-based Ancora Holdings Group LLC, which holds about 1.7 million shares in Algonquin as of March 31, has argued that the company should focus on its utility assets.

“I think carving up the renewables piece of the business, which is certainly lumpier and not a great public market asset, is probably where they need to take this business,” Patrick Sweeney, portfolio manager at Ancora, said during an interview in April.

Chris Seiple, vice-chair of energy transition and power and renewables at Wood Mackenzie, a global consultancy group, said that boards of directors at some utilities are likely concluding that it may not be worth deploying capital to clean energy investments given their lower returns.

Investing in a regulated utility tends to generate a return on equity of 9 per cent to 10 per cent. For investments in renewable energy, though, returns lag within a typical range between 7 per cent and 8 per cent.

“I think that has clearly been one of the drivers of asset sales,” Mr. Seiple said.

Another is the sheer complexity of explaining to investors how two businesses with different cash flows, taxes, debt and regulatory environments can be valued together, especially when problems emerge.

“The regulated utility business is a different model from the renewables business, and that can lead to some challenges when you put the two together,” said Rupert Merer, a sustainability and clean tech analyst at National Bank Financial.

Algonquin is facing its challenges at a time when investor interest in clean energy has cooled.

The iShares Global Clean Energy exchange-traded fund – an ETF that gives investors one-stop access to a global basket of about 100 clean energy-related companies, including First Solar Inc. and Vestas Wind Systems A/S – has fallen 45 per cent from its record high in early 2021. The fund, a proxy for renewables, is trading near three-year lows.

Northland Power Inc. and Brookfield Renewable Partners LP, two Canadian-based clean energy stocks that are also included in the iShares fund, have fallen 37 per cent and 47 per cent, over a similar period.

At the same time, some of the world’s biggest energy producers, awash in profits generated from crude oil and natural gas over the past year, are softening their earlier commitments toward investing in wind and solar assets.

In Europe, Shell and BP PLC – which, reported a record combined profit of US$67.5-billion in 2022, or more than double their 2021 profits – have defended their fossil fuel-generating business models in an attempt to lure back investors turned off by their diversification into renewables.

Calgary-based Suncor Energy Inc., which has also enjoyed a surge in profits from crude oil, sold its wind and solar assets to Canadian Utilities Ltd. in a $730-million deal that closed in January.

A key question now: What sort of market exists for Algonquin’s renewable assets?

Clean energy has long attracted socially conscious investors who want to align their money with greener pursuits and back a promising solution to climate change, but the appeal has broadened in recent years.

The rise of environmental, social and governance (ESG) investing principles has helped drive clean energy into the mainstream: Global assets under management rose to US$18.4-trillion by 2021, up from US$2.2-trillion in 2015, according to PwC.

As well, falling prices for producing renewable power underscored its potential as a viable alternative to fossil fuels.

But stocks associated with clean energy really took off in 2020, when ultralow interest rates drove up valuations of companies with strong growth prospects. The COVID-19 pandemic – and the search for a vaccine – may have turned investor attention toward solutions to other global crises such as climate change. And Joe Biden’s victory in the U.S. presidential election came with a strong environmental mandate.

The iShares Global Clean Energy ETF rallied more than 240 per cent from March, 2020, to its high in January, 2021. Algonquin rode this upsurge, too: The share price peaked in February, 2021, at $22.54. In May, the company announced a 10-per-cent increase to its quarterly dividend.

Around this time, though, cracks in its business model and challenges to the broader renewables sector were starting to appear. U.S. inflation began to stir, rising above the Federal Reserve’s target of 2 per cent in March, 2021, and reaching a four-decade high of 9.1 per cent over the next 15 months. Many of the growth stocks that had benefited most from low interest rates faltered as central banks hiked rates aggressively.

Renewable energy was affected in other ways, too. Disrupted supply chains for wind and solar components caused delays, while increasing resistance from residents opposed to wind and solar installations has undermined growth forecasts.

“The economics aren’t the hard part anymore. It’s the interconnections, transmission capacity, local permitting and the opposition to renewables that has emerged in some places,” Mr. Seiple said. A project that might have taken four years to bring online before, he added, can now take six years.

These setbacks emerged at a time when there is greater competition for investor attention, particularly from fossil fuels. The price of crude oil, which had collapsed during pandemic lockdowns in 2020, recovered as the global economy found its feet and demand for fossil fuels soared. West Texas Intermediate, a North American benchmark for oil, rose to a high of about US$120 a barrel in June, 2022, from below US$50 for much of 2020.

Energy producers made a bundle last year, and shared the bounty with investors by raising dividends and buying back their own shares. Among major sectors in the stock market, oil and gas producers led the way last year, as clean energy stocks faltered.

Algonquin also faced specific issues. The company financed part of its growth by issuing new shares to pursue large acquisitions, diluting existing shareholders along the way. Some investors eventually soured on this strategy, especially when growth faltered.

In its third-quarter results, released in November, Algonquin reported a 25-per-cent dip in its operating profit, surprising analysts. By January, investors who had flocked to the company as a sound long-term bet on clean energy were left with a depleted dividend, a depressed share price and a lot of questions about its future.

Despite the lower share prices of clean energy stocks, which translates to lower valuations for assets, observers believe that the growth of the renewables sector remains stronger than ever.

The International Energy Agency expects that global renewable energy capacity will increase by 75 per cent by 2027, an increase from it previous forecast. Wood Mackenzie expects U.S. clean-energy capacity will quadruple over the next decade, underscoring wind and solar energy development and raising the allure of existing assets.

“Demand for assets is really high,” Mr. Seiple said. “There is a lot of capital sitting on the sidelines, looking for an opportunity in renewables.”

When Brookfield Renewable announced in mid-June a deal to acquire Duke Energy’s renewable assets, Brookfield CEO Connor Teskey noted the supportive regulatory backdrop and growing demand for renewable energy.

More diversified institutional investors also remain interested in expanding their exposure to clean energy as a long-term bet on green transition. Pension funds are “as willing as before to go after those steady, more predictable rates of return in a sector that they know is poised to grow,” said Jason Dion, senior research director at the Canadian Climate Institute.

Algonquin’s decision on what to do with its renewable assets could come in various forms. One of the simpler approaches: It could sell its 42-per-cent ownership stake in Atlantica Sustainable Infrastructure PLC, a London-based clean energy company.

Mark Jarvi, an analyst at CIBC World Markets, estimated in a July research note that the sale could generate $1.4-billion, before tax, if Algonquin gets a premium for its shares. The money raised would go toward repaying high-interest floating rate debt, which would improve the company’s debt profile.

The sale offers a logical first step for Algonquin, he believes, because there is little strategic alignment between the two companies. As well, shares are easier to unload than Algonquin’s renewable assets, which he values at $3.2-billion and could be held until market conditions for clean energy improve.

Mr. Smith, the Starboard investor, is pushing for a significantly bigger split that would also include the renewable energy group as a whole or in multiple transactions. This way, Algonquin could repay debt and buy back shares. Earnings on a per-share basis would rise, given that profits would be divided among fewer shares. And the dividend would be safer.

The utility, Mr. Smith said, would be “significantly greener than peers, with approximately one-third of its electric generation capacity coming from renewables and no coal exposure.” The water distribution business, he added, remains “extremely valuable.”

On its own, he believes, the utility would command a higher valuation, rewarding shareholders with a rising share price.

Mr. Banskota did say, though, that maintaining the existing structure, with power and utilities still joined by the ampersand in its official name, was an option. However, it is unclear how the status quo will improve the company’s balance sheet and bolster the dividend – let alone placate investors who have soured on a stock that once appealed on a number of levels.

As Mr. Merer put it, investors attracted to the utility might not understand the renewables business, renewable-focused investors might be put off by the larger utility and general investors might not warm to a company that cut its dividend this year.

“I think if they made this a pure-play utility – plain vanilla and easy to understand – they would get investors back,” Mr. Merer said.

Next month, Algonquin will reveal its plan. The way forward, it seems, is clear.

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