Algonquin: Brace For Chaos But Don’t Run

Summary:

• Algonquin Power & Utilities Corp. cut its dividend significantly at its Investor Update yesterday. Did you not expect it?
• The market had already baked in the potential for a dividend cut. Hence, a 40% implying an NTM dividend yield of 6.5% isn’t all that bad.
• With Algonquin Power & Utilities Corp. moving back to its December lows due to market volatility, investors who missed buying have another fantastic opportunity.

Just like that, Algonquin Power & Utilities Corp. (NYSE:AQN) stock has nearly given back all its gains for January after the company issued its scheduled Investor Update on January 12. Accordingly, the company cut its quarterly dividends by 40%, to $0.1085 per share.

As part of a series of “decisive actions,” the dividend cut likely wasn’t unexpected. We highlighted this in our previous article in late December, postulating that AQN’s valuation had likely baked in a significant markdown in its forward dividends. Wells Fargo (WFC) analysts also updated in early January, anticipating “aggressive strategic actions to firm its financial footing, including a material dividend cut and a paring back of capital investment.”

Therefore, we believe yesterday’s AQN update likely didn’t stun dividend investors who had intended to flee, as they have probably run. Those remaining, including investors who bought/added at its recent lows, likely believe that Algonquin Power & Utilities Corp. could execute better moving ahead.

Some AQN bears contend that the U.S. Federal Energy Regulatory Commission (FERC) recent rejection of its Kentucky Power acquisition could have added more headwinds to its near-term execution. However, AQN management also stressed on its conference call that they are still discussing with the FERC and working on mitigating measures, even though the company is not ready for public disclosure yet.

Despite that, management highlighted that the company’s revised adjusted EPS of $0.58 (midpoint) for FY23 has likely reflected the near-term headwinds. Notwithstanding, management’s outlook also incorporated the accretion from Kentucky Power, suggesting that it needs to meet the FERC’s requirements before the end of April. As such, we believe some investors could be concerned with potential execution risks resulting from a failure to consummate the acquisition, which could further impact its earnings outlook further.

Hence, we urge investors to continue monitoring the developments closely, even though AQN’s price action likely implied market operators have reflected significant challenges. Therefore, we assessed that more constructive developments over the next few months could attract long-term investors to lift buying sentiments on AQN.

Management highlighted that it remains confident in meeting its curtailed dividend per share (DPS), with CFO Darren Myers accentuating that “it is a sustainable dividend despite whatever actions we end up taking.”

Hence, investors with high conviction over Algonquin’s execution and closure of its Kentucky Power acquisition could capitalize on its revised NTM dividend yield of 6.5% (10Y average: 4.8%).

Some investors could argue that AQN traded at 10% yields not too long ago at similar price levels before the cut. But, to make things clear, that level was not sustainable because market operators had already priced in a cut. Hence, the cut has happened, and AQN stock’s yield has moderated. As such, unless investors believe management could fail to deliver its EPS outlook for 2023/24, behooving more significant cuts, these levels could likely hold robustly.

But does AQN’s current price action concur with our thesis? Let’s see.

Look at AQN’s December lows, which coincided with its August 2015 lows. Then consider AQN’s still forming January lows as buyers continue to defend the levels it held in December.

Price action is forward-looking. The market looks ahead, as implied by its dividend yields before AQN’s update yesterday. Accordingly, we assessed that a medium-term recovery seems increasingly likely as long as market operators continue to hold this level.

Hence, investors need to be able to tolerate significant volatility over the next few months at least. We urge investors to use deep pullbacks to add exposure to Algonquin Power & Utilities Corp. and not chase upward momentum.

An Algonquin Power & Utilities Corp. mean reversion back to the $9 level at the current levels could generate a potential upside of 35% (in price-performance terms). For an integrated utility player like Algonquin Power & Utilities Corp., we believe the reward/risk is attractive.

Rating: Buy (Reiterated).

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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