A High-Growth Utility for a Rising Income

Income investors would love this stock. It offers a growing dividend in a stable and growing industry. And get this. The company yields +5% today and has higher growth potential than its peers! Just how fast can its dividend grow and what kind of returns can you expect? Read on to find out.

Algonquin Power & Utilities Corp (TSX:AQN)(NYSE:AQN) has been busy making merger & acquisition deals since late 2010. The first deal completed in Q1 2011. Fast forward to today, the utility now has C$6.3 billion of North American assets.

solar power facility

Photo: M.O. Stevens. Cropped. License: CC by 3.0 Source: Wikimedia Commons

Algonquin’s portfolio

Firstly, Algonquin owns and operates wind, solar, hydroelectric, thermal, and natural gas power-generating facilities, which have an installed capacity of 1,300 megawatts.

Secondly, the utility provides essential water, electricity, and natural gas utility services to more than 560,000 U.S. customers. These are rate-regulated services that generate stable and predictable earnings for the utility.

Thirdly, the company is involved in rate-regulated electric transmission and natural gas pipeline systems in the U.S. and Canada.

A growing dividend

Since Algonquin pays a U.S. dollar-denominated dividend, Canadian investors holding it on the TSX will experience yield volatility based on the strength of the U.S. dollar to the Canadian dollar.

wind-power facility

Photo: warrenski. License: CC by 2.0 Source: flickr

Coinciding with its M&A efforts, it’s not surprising that Algonquin has been increasing its dividend at a compound annual growth rate (“CAGR”) of 15% since 2011 (thanks partly to the stronger USD against the CAD). On a constant currency basis, Algonquin’s dividend has increased at a CAGR of 9.9%.

As the diversified utility has been growing its U.S. assets, it wasn’t surprising that it began trading on the NYSE at the end of November.

Currently, Algonquin yields 5.1% and targets a funds from operations (“FFO”) payout ratio of 33-40%, which leaves the remaining FFO for running and growing the business.

The utility has increased its dividend for five consecutive years (this year is the 6th). Its growth plan supports continued dividend growth of 10% per year for the next five years.

Going forward, where will Algonquin’s growth come from?

Algonquin plans to grow:

  • organically,
  • through development,
  • by making acquisitions, and
  • by optimizing its existing assets

Algonquin’s acquisition of Empire District Electric Co (NYSE:EDE) should close by early 2017. The transaction will increase Algonquin’s distribution customers to 800,000, and its distribution business will operate in 13 states and remain 100% rate-regulated. These allow Algonquin to generate stable, growing cash flows to maintain a durable dividend.

After the transaction completes, Algonquin’s unregulated business will make up more than 30% of its operations. The lower U.S. corporate taxes (expected from Trump’s presidency) will benefit its unregulated business, by translating to higher profits.

Algonquin plans to invest C$9.68 billion from 2017 through 2021. The Empire acquisition makes up 35% of the growth plan. Based on the type of asset, non-rate based generation makes up 24% of the growth plan, rate-based generation makes up 37%, transmission makes up 7%, and distribution makes up 31%.

Management expects the growth of Algonquin’s earnings before interest, taxes, depreciation, and amortization (“EBITDA”), earnings per share (“EPS”), and funds from operations per share (“FFOPS”) growth as follows, based on a forex of C$1.35 to US$1.

Algonquin creates value

Source: Investor Day Presentation 2016 – Slide 25 (pdf)

Summary, Valuation, and Estimated Returns

Algonquin should be closing the Empire acquisition in early 2017. Then, it’d focus on integrating the acquisition. Algonquin’s 5-year growth plan of C$9.7 billion (including the Empire acquisition) is laid out to support dividend growth of 10% per year through 2021.

So, investors can expect estimated annualized returns of 15% from an investment today. The shares are fairly valued based on today’s valuation but attractive on a forward-looking basis.









Across Thomson Reuters’s 10 analysts, the utility’s 12-month price target range is C$12.30-16 with a mean price target of C$14.20, implying an upside potential of 27%.

At the end of November, Bank of Nova Scotia’s analyst maintained his 12-month price target of C$14 after hearing a more positive story from Algonquin’s investor day presentation.

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Disclosure: At the time of writing, the author owns shares in Algonquin.

Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.

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