After a difficult 2022 for independent power producers and infrastructure stocks, iA Capital Markets analyst Naji Baydoun is more optimistic about this year, believing the outlook for growth remains “solid.”
“Most of our coverage universe posted negative share price performance in 2022, primarily due to persistent inflationary pressures which have impacted both company costs and the monetary policy outlook,” he said in a report released Wednesday. “As (1) interest rates shot higher, and (2) due to uncertainty around the ultimate levels at which rates could stabilize (and the path to get there), equities in our coverage universe were impacted by the rising cost of capital. Despite these negative macroeconomic headwinds, we note (1) positive industry developments (i.e., increased global commitments to decarbonization), and (2) solid underlying company fundamentals and growth outlooks. On average, companies across our coverage universe delivered negative 5-per-cent total shareholder returns (TSRs) in 2022, while our Top Picks generated a 2-per-cent compounded TSR compared to negative 6 per cent for the S&P/TSX Composite Index.
“The upside is in the balance sheet (not growth). Underlying consensus estimates broadly increased throughout 2022; the combination of improving growth expectations and declining share prices have made select equities more attractive to own. Although incremental growth initiatives and continued project de-risking/execution remain important drivers of shareholder value creation, we believe that funding will be the key catalyst to watch in 2023. Given the higher cost of capital environment, companies that can efficiently source low-cost non-dilutive capital should be best positioned to deliver the most amount of upside potential.”
Mr. Baydoun thinks the fundamental outlook for most companies in his coverage universe is encouraging, predicting “healthy” near-term and medium-term growth outlooks.
“Broadly speaking, we expect companies under coverage to be able to deliver mid to high single-digit cash flow per share growth over the medium-term, with a handful of companies also expected to provide investors with dividend growth relatively in line with overall cash flow per share growth over time,” he said. “When looking at the evolution of underlying consensus estimates over 2022, we note particularly strong upward revisions at companies that (1) had positive torque to higher power prices (NPI, BLX, INE, TA, CPX), (2) executed on accretive M&A opportunities (INE, CPX, BIP, PIF, HEO), and (3) benefited from margin expansion and positive exposure to inflationary dynamics (SXP, BIP). On the flip side, we note substantial downward revisions to estimates at businesses with (1) negative exposure to supply-chain and inflationary cost pressures (ARE, BDT), (2) significant project delays (UGE), and (3) weaknesses in their balance sheets/financial risk profiles (AQN). The broad variance of performance (both from a financial and share price perspective) reinforces the potential excess return generation that can be achieved from active management in the Power & Infrastructure sectors (in our view).”
He named a pair of stocks as his “top picks” for the first quarter of the year. They are:
* TransAlta Corp. with a “strong buy” rating and $16 target, matching the average on the Street but down from $16.50 previously.
“We consider TA our preferred merchant and value IPP play in the Canadian Power sector,” said Mr. Baydoun. “TA offers investors (1) a balanced mix of contracted and merchant powe rexposure, (2) improving balance sheet and cash flow fundamentals, (3) long-term upside to rising Alberta power prices, (4) a discounted relative valuation versus IPP peers, and (5) both downside protection and upside optionality from Brookfield’s strategic support. We continue to like TA’s clean energy transition plan, which we believe should (1) reduce the Company’s risk profile, (2) drive additional growth and diversification, and (3) support valuation multiple expansion over time (see here for more details). For 2023, we see the strong Alberta power market environment as a key near-term tailwind to financial performance; this should also support excess FCF generation, which provides capital allocation optionality (e.g., buybacks, self-funded internal and external growth initiatives). We expect TA to make steady progress on its existing growth and announced positive FID on new renewable power projects; the Company’s success in potentially accelerating its organic growth in 2023 could also provide additional comfort for investors about the Company’s overall trajectory. Finally, additional clarity on a potential corporate simplification plan could also support a higher relative valuation.
* Brookfield Infrastructure Partners LP with a “strong buy” rating and US$46 target, down from US$47.50 but above the $44.87 average.
“We view BIP as a unique and diversified way for investors to play the broad long-term infrastructure investment theme, with (1) access to a global, large-scale infrastructure investment platform (ownership interests in more than US$70-billion of assets), (2) defensive cash flows (90 per cent of FFO regulated/contracted), (3) visible and sustainable organic cash flow growth (6-9 per cent per year, CAGR [compound annual growth rate] 2022-27E), (4) potential upside from accretive M&A, and (5) attractive income characteristics (4-per-cent yield, 60-70-per-cent long-term FFO payout, and a 5-9 per cent per year dividend growth target). BIP has delivered record financial results in 2022 and once again easily beat its capital deployment targets. The Company and management’s exceptional execution track record gives us confidence that it can continue to exceed its internal objectives and deliver double-digit cash flow per share growth over the medium-term. We expect large-scale asset monetizations to (1) surface/crystalize underappreciated value from BIP’s existing portfolio, and (2) support funding for growth initiatives (i.e., internal sourcing of capital for M&A). We also see the potential for BIP to capitalize on market volatility/dislocations to execute on strategic and accretive M&A opportunities (supported by its robust access to capital). By our calculations, the shares are currently trading at some of the most attractive valuation levels on per-unit-of-growth in recent years; we continue to see BIP as a standout growth vehicle for long-term shareholders in the current macroeconomic context.”
Mr. Baydoun also made these target changes:
- Brookfield Renewable Partners LP ( “buy”) to US$38 from US$40. Average: $37.14.
- Capital Power Corp. (“hold”) to $50 from $52. Average: $52.31.
- TransAlta Renewables Inc. ( “buy”) to $14.50 from $15.50. Average: $14.31.