Algonquin plans to spend US$2.5-billion on replacing aging assets and making investments in new ones.Courtesy of Algonquin Power
Step one in Algonquin Power & Utilities Corp.’s AQN-T turnaround: Shed renewable assets. Step two: Emphasize growth potential as a pure play utility. Step three: Deliver on potential.
With step two in the bag after the company released a fresh outlook this week, which included better-than-expected profit growth through 2027, the share price rallied 16 per cent on Tuesday.
Even after losing some momentum as the week wore on, the stock is still up about 26 per cent this year, as of Thursday’s close on the Toronto Stock Exchange.
But the strong gain, which broke four years of crushing downward momentum, puts a lot of pressure on step three – the delivering part.
If you’ve lost track of Algonquin, you’re probably not alone. It used to be a go-to stock for investors looking for a winning combination of renewable power, stable utility assets and a steadily rising dividend.
A series of missteps related to the company’s rapid expansion and bloated debt sent the share price plummeting. After it slashed its dividend – twice – the share price descended to an 11-year low in January.
There was some conjecture that Algonquin would face yet another ignominy: getting tossed from the S&P/TSX 60 index of blue-chip companies for being too withered.
Now, after selling most of its renewable energy assets, Algonquin is emerging with a fresh determination to become more profitable and efficient under new chief executive Rod West.
To underscore the point, Mr. West referred to Algonquin as a “pure-play” utility 10 times in a conference call with analysts this week, drumming home the idea that the company is now focused on regulated electricity, natural gas and water distribution.
No wonder. Utilities are hot stuff right now, given rising energy needs as power-hungry data centres spring up in North America catering to demands for artificial intelligence. Economic concerns related to rising tariffs adds to their allure.
In Canada, the utilities sector trails only materials – largely gold producers – and consumer staples so far this year. The U.S. utilities sector has outperformed the S&P 500, and the tech sector, by more than four percentage points this year.
And in terms of valuations, standout Hydro One Ltd. H-T commands a higher price-to-earnings ratio than Google parent Alphabet Inc.
Algonquin would like some of this love.
Mr. West – who became CEO three months ago after leaving his position as group president of utility operations at New Orleans-based Entergy Corp. – believes that Algonquin can become a “premium” utility.
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By his definition, that means operating in attractive regulatory jurisdictions, gaining investor confidence with consistent growth and building financial strength with a solid investment-grade credit rating.
He has some work to do: “To become premium, we got to get to good,” Mr. West said on the conference call.
But his upbeat forecasts were what likely inspired investors to jump on this turnaround opportunity while it’s still in its formative stages.
Algonquin plans to spend US$2.5-billion on replacing aging assets and making investments in new ones. These capital expenditures should increase the utility’s rate base – assets that generate income – to US$9.1-billion by the end of 2027, or growth of about 5 per cent a year.
It plans to cut its operating expenses to a target of 31 to 33 per cent of revenues, which is in line with peers. This, combined with successful electricity rate hikes, should help Algonquin maintain its investment grade credit rating, drive greater cash flow and improve profitability.
Brian Chin, Algonquin’s chief financial officer, expects profit should rise to a range between 42 and 46 US cents per share by the end of 2027, up from an estimated 30 to 32 US cents per share this year.
That implies profit growth of about 42 per cent in just two years, and leads to one more benefit: Higher earnings will lower the dividend payout ratio (the share of profits distributed as dividends) below 70 per cent, from well above 100 per cent currently. That should restore confidence in the quarterly distribution.
A turnaround opportunity in the normally staid utilities sector is undoubtedly attractive.
If Mr. West delivers on his targets, investors who buy in to Algonquin’s potential will be rewarded with a stock that looks cheap next to bigger, sturdier players such as Emera Inc., Fortis Inc. and Hydro One.
But with Algonquin’s share price well ahead of its peers this year, the turnaround comes with a risk: Much of it is already priced in.