Maritimes utility Emera Inc. EMA-T is a yield-investor fave: The company has been raising its payout for more than a decade, and told Bay Street last week that it’s targeting 2-per-cent to 4-per-cent annual growth in its dividend through 2024.
What it says in its annual financial statements, however, offers a more worrisome picture.
Emera says that it has entered into derivative contracts that could require it to post hundreds of millions of dollars of collateral if the company’s credit rating ever slips below investment grade. Retail investors may think such an event is hardly likely, given the company’s track record of strong dividend increases.
Yet the company has been posting junk-bond-quality financial metrics for several years. Most of those numbers took a step even further backward in 2021. It’s only through the good graces of the debt-rating agencies that Emera stays at investment grade, with the result that the company’s partners in the derivatives can’t come calling for more collateral.
None of this suggests Emera’s dividend is at risk of elimination, or even a cut. But investors who love their payouts in the Canadian utilities sector need to question whether Emera is likely to deliver on its dividend-growth promises.
Veritas Investment Research analyst Darryl McCoubrey, the Street’s Scrooge on Emera, highlighted the company’s disclosure in a recent report. Until recently, Mr. McCoubrey had the only “sell” rating on Emera, while analysts at most of the major Canadian banks have a “buy” rating on the stock.
Emera had more than $14.2-billion in long-term debt at the end of 2021 and another $1.7-billion in short-term borrowings. It also had $682-million in derivative contracts, and Emera says in the event of a downgrade to junk status, it could be required to post collateral for them. Emera had $394-million in cash at year-end.
Mr. McCoubrey believes the impact of a downgrade – posting collateral and possibly refinancing borrowings – could be significant. The key question is how likely that downgrade may be.
Mr. McCoubrey wrote that Emera’s debt service metrics are “widely offside investment grade targets,” and the company hasn’t registered numbers in that investment-grade range since 2016. In 2021, it was well short of its own goal of annual “funds from operations,” a kind of cash-flow measure, equalling 12 per cent of total debt. That number fell from 9 per cent in 2020 to 8 per cent in 2021, Mr. McCoubrey notes.
Moody’s Investors Service, which last published on Emera in June, 2021, acknowledges that Emera isn’t putting up investment-grade numbers. Jeffrey Cassella, an analyst at Moody’s, said “Emera’s credit metrics remain persistently weak,” with Moody’s own measure, cash flow from operations before changes in working capital, at 9.2 per cent of debt, “well below its downgrade threshold of 12 per cent.”
Well, why not downgrade, then? For one thing, utilities, with their steady, regulator-approved revenue, are seen as safer than less-regulated businesses. Two, Moody’s is now looking forward, not backward, and expected Emera’s high-growth Florida utility, Tampa Electric Co., to produce improved profits thanks to a rate case that it indeed won last October. Mr. Cassella expects Emera to hit Moody’s investment-grade target of funds from operations to total debt of 12 per cent in 2022 and sustain it thereafter. (About 65 per cent of Emera’s profits come from the U.S., nearly all of that from Florida.)
And that is also the company’s position when I questioned it about Mr. McCoubrey’s concerns – the past is past and the company is in much better shape now. “While we appreciate Veritas’ views as being informed by our most recent financials … we think there is much more to the story that is missed by only looking backwards,” Emera spokeswoman Dina Bartolacci Seely said in an e-mail.
She pointed to Emera’s recent public comments to investors. The company says it expects increased cash flow in the coming years, and chief financial officer Gregory Blunden said in a February earnings call that a 6-per-cent decline in operating cash flow in 2021, which included unexpected expenses at its New Mexico natural gas company, “does not change our views” about Emera’s forecast for increased cash flow.
Mr. McCoubrey writes that Emera’s long-term spending plans “show little regard for downside risk,” with almost 50 per cent of capital expenditures funded with new debt, “well above its own plan, which calls for only 25 per cent to 35 per cent debt funding.”
Net debt is now more than eight times Emera’s EBITDA, or earnings before interest, taxes, depreciation and amortization, according to S&P Global Market Intelligence, higher than 2020 and one of the worst figures in its history. You can’t calculate a debt-to-free-cash-flow ratio because Emera spent $1.1-billion more on capital expenditures in 2021 than it made in operating cash flow. Then it paid $500-million in dividends.
The utility in being a utility, so to speak, is that Emera can have negative free cash flow with less downside than companies in other industries. As long as it has a regulator somewhere that finds its capital program appropriate, it can set future utility rates high enough to recover that spending. In this, Emera is different than all sorts of Canadian companies in other sectors that have told a great dividend story and paid out money that it never really generated from its businesses.
“It ultimately comes down to this,” Mr. McCoubrey said in a follow-up interview. “If you’re willing to risk that there’s no consequence to Emera having non-investment-grade credit metrics, then its higher-than-average rate-based growth profile makes it an appealing income growth story.”
“The only reason I have a sell on it is that it is not valued at a discount and it has this risk,” he said. “I can probably get comparable returns on another utility like Hydro One and not have this … kind of clouded credit risk maybe you don’t need to take.”
That warning of clouds is worth heeding for income investors who are banking on sunny days ahead for Emera in the Sunshine State.
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