Algonquin Power & Utilities Corp. AQN-T is surrounded by uncertainty, but one thing is clear: As a stand-alone utility, it looks like a compelling investment.
Right now, the company is a flailing combo.
The utilities side of the business distributes electricity, water and natural gas to 1.2 million customers, mostly located in four U.S. states. Algonquin also owns and develops renewable energy – specifically, wind and solar power – and has an ownership stake in Atlantica Sustainable Infrastructure PLC.
The two divisions fit well together for years, and Algonquin delighted investors with a green stock and a big dividend – until sputtering profits and rising borrowing costs hammered the share price last year and the company slashed its dividend by 40 per cent in January.
This week, Algonquin announced that it will pursue a sale of its renewables assets, siding with a number of activist investors who had argued that the utilities division would operate better on its own and attract investors back to the stock.
If investors were looking for clarity from the announcement, though, they didn’t get it.
There is no buyer for the renewables yet and there is no indication of whether the assets will be sold whole or piecemeal – though Christopher Huskilson, the company’s interim chief executive officer, said he believed there was greater value in selling the assets as one.
What’s more, Mr. Huskilson declined to provide an expected price range for the sale. And with clean-energy stocks continuing to struggle this year – the iShares Global Clean Energy ETF, an exchange-traded fund that provides global exposure to the green-power theme, is down 15 per cent – it looks like a buyer’s market.
“Despite a confident tone from Algonquin on the ability to transact at a fair valuation, it offered no details on timeline and expected proceeds,” Mark Jarvi, an analyst at CIBC Capital Markets, said in a note.
The share price, which rebounded as high as $11.93 in May, fell to six-month lows this week. The stock closed Friday at $10.04 in Toronto, down 2.4 per cent.
Algonquin is also facing stiff competition for investor attention.
For anyone interested in Canadian renewable energy stocks with strong growth, there are plenty to choose from, including Northland Power Inc., Boralex Inc. and Brookfield Renewable Partners LP. Investors who lean toward safe, dividend-generating utilities can find opportunities in Fortis Inc., Emera Inc. and Hydro One Ltd.
So why bother with Algonquin?
The company’s strategy, backed by activist investors, goes like this: The proceeds from the sale of the renewables assets can be used to pay down debt and buy back shares, bolstering Algonquin’s investment-grade credit rating and its dividend.
Though valuations for renewables assets are down from recent highs, owing to rising interest rates that skewered many growth stocks over the past year, demand for clean energy among pension funds and other long-term investors remains strong.
This demand should lead to a reasonable sale price by today’s standards. In any case, Algonquin’s floundering stock implies that low expectations are already baked in.
As a regulated utility, Algonquin could shine. Without the renewables business, the utility will offer investors a simpler and more predictable business that can be easily compared with other utilities.
Starboard Value LP, one of the activist investors that had pushed for a restructuring, argued in a letter to Algonquin’s strategic review committee last month that the utility is “top tier,” yet valued at a substantial discount to peers.
The investor believes that the water distribution business is extremely valuable, and should trade at a premium relative to electricity and gas utility assets.
Starboard did not respond to a request for comment following Algonquin’s announcement on Thursday, but analysts have weighed in.
David Quezada of Raymond James estimates that the stand-alone utility can trade with a valuation of 16 to 17 times earnings per share, up from the current price-to-earnings ratio of 13.
Not everyone is so sure about this rosy outlook, though. Mr. Jarvi, for one, believes that the valuation of the utility will lag the peer average, given specifics related to Algonquin’s jurisdictional footprint. He estimates the P/E ratio will be just 14, which could undermine a recovery in the stock.
The retreating share price over the past two trading days suggests that many other investors are similarly skeptical.
Still, the uncertainty surrounding Algonquin’s plans isn’t necessarily a bad thing. The depressed share price – it has fallen 45 per cent over the past 12 months – points to a beaten-up and unpopular stock that looks cheap.
The downside risk seems limited, while the upside opportunity appears achievable. For success, the utility merely needs to start trading like a utility.