Algonquin Power & Utilities Faces Challenging Future That May Limit Returns

Algonquin Energy & Utilities Corp. (NYSE:AQN) (TSX:AQN:CA) owns and operates a spread of regulated and non-regulated energy belongings, together with era, distribution, and transmission utilities. On January 12, AQN supplied an investor replace the place they offered their plans to enhance their enterprise by decreasing prices, sustaining their credit standing, and minimizing the necessity for brand new fairness financing. One of many key actions they may take is a 40% discount in dividends and suspending their DRIP program. Additionally they plan to promote belongings price $1 billion and proceed to pursue the acquisition of Kentucky Energy (‘KP’).

On this article, I’ll summarize the important thing factors from the investor replace and replace my valuation. In a nutshell, I consider the truthful worth is $8 per share.

Concerning EPS, AQN forecasts a spread of $0.55 to $0.61 per share for 2023. The discount is because of delays within the KP acquisition, strain from rates of interest, and one-time beneficial properties from asset recycling in 2022.

AQN goals to attain a normalized annual EPS development of 5% to eight% by specializing in natural development. Nonetheless, there are challenges, equivalent to larger tax charges and elevated rates of interest. Regardless of this, AQN has secured about $400 million in floating-rate debt at 4.5%. There may be a possible impression on earnings as a result of expiration of Manufacturing Tax Credit for a few of their older wind farms, leading to decrease revenue from the sale of their renewable power. On the constructive facet, AQN expects to profit from rate-case changes in a few of its regulated operations and additional natural development in its renewable power portfolio. The success of AQN’s plan to dump $1 billion of belongings will rely upon which belongings are offered and the worth they’re offered for.

AQN intends to lower the quarterly dividend to $0.1085 per share ($0.4340 per share yearly) from $0.1808 per share beginning in Q1 2023. Administration expects to save lots of over one billion in a 5-year interval by its dividend reset plan. This plan goals to strengthen the corporate’s monetary basis, enhance its monetary flexibility, and help its balanced funding plan. The dividend reset can be anticipated to facilitate long-term earnings and AFFO per share development. Administration plans to develop its dividend sustainably and align with its EPS development. The dividend reset will carry the 2023 payout ratio and dividend yield extra in step with its friends.

Regardless of being rejected by the FERC in December 2022, AQN and American Electrical Energy Firm Inc. (AEP) plan to proceed working to shut the Kentucky Energy acquisition. In my view, AQN will probably be unsuccessful within the enchantment. This may very well be considered as constructive information because it might alleviate the steadiness sheet.

AQN plans to keep up its BBB credit standing by implementing a balanced funding plan, which incorporates no new fairness financing till the top of 2024 and decreasing capital spending. The corporate goals to boost one billion by renewable asset recycling transactions and extra asset gross sales to pay down debt and stay compliant with its credit score metrics after the KP acquisition. To realize this, AQN has dedicated to not interact in new fairness financings and suspended its DRIP as of the Q1 2023 dividend fee. AQN had roughly $2.3 billion of accessible liquidity on credit score amenities on the finish of 2022.

The one billion asset recycling plan entails promoting renewable belongings with proceeds anticipated in 2023 and 2024. AQN accomplished its inaugural asset recycling transaction by promoting working U.S. wind belongings in December 2022. Whereas AQN has not supplied particular particulars on which different belongings could also be offered, I consider its stake in Atlantica Yield (AQN owns 44%) may very well be a possible candidate on the market.

AQN has supplied steerage for 2023 and expects adjusted EPS of $0.55-$0.61 per share, down year-over-year from $0.675 in 2022. The elimination of one-time beneficial properties is the principle issue contributing to this lower in earnings. The drop in adjusted EPS can be largely pushed by larger rates of interest on current debt and the upper price of servicing incremental debt wanted to fund the Kentucky Energy transaction.

Valuation

My goal worth is $8 per share. That is based mostly on a DCF mannequin utilizing a price of capital of 6.4%. The assumed unlevered beta corrected for money is 0.41 (supply). I count on revenues to extend by 7% in 2023, in step with administration’s steerage. I count on a headwind as a consequence of rates of interest (15% of debt is variable fee) and inflation impacting the medium-term. In consequence, I count on 2023 EPS barely decrease than steerage at 50 cents per share.

This valuation implies 1.06x e-book worth, which is in step with the forecasted ROE that’s 100-150 bps above the price of capital within the medium time period.

Conclusion

AQN is taking strategic actions to enhance its monetary place and obtain long-term development. The corporate is implementing a balanced funding plan, decreasing prices, and suspending its DRIP program. AQN can be specializing in natural development and increasing its renewable power portfolio whereas pursuing the acquisition of Kentucky Energy. The dividend reset plan will strengthen the corporate’s monetary basis, enhance its monetary flexibility, and help its balanced funding plan.

Nonetheless, challenges equivalent to larger tax charges, elevated rates of interest, and potential impression on earnings from the expiration of Manufacturing Tax Credit for a few of their older wind farms are anticipated.

I count on AQN to have a decrease return on fairness than its previous round its price of capital. Thus, by the valuation of $8 per share appears justifies as it’s near the e-book worth per share. I’d keep on the sidelines until we have now extra readability on KP and extra information on the asset divestitures.

Editor’s Be aware: This text discusses a number of securities that don’t commerce on a significant U.S. alternate. Please concentrate on the dangers related to these shares.