TD commentsEvent
We are adjusting our outlook to reflect an assumed Q3/23 closing of the Kentucky Power acquisition and in advance of management articulating revised targets for earnings growth, investment plans, and capital-allocation priorities.
Our revised estimates reflect a lower earnings starting point in 2023 and an expectation of flat 2024 EPS. With a lack of clarity around growth plans, we expect Algonquin to lower its dividend by 50% in H1/23 based on a diminished earnings base and a more conservative payout ratio target.
Impact: NEGATIVE
In our view, a significant dividend reduction is anticipated by investors. With an assumed 50% cut, the pro forma dividend yield of 5.2% would be above both the 4.5% average for other Canadian utilities and the 4.4% average for Canadian IPPs. The adjusted payout ratio is equivalent to 61% of 2023E EPS versus management's previously articulated 80-90% target.
Following FERC's Kentucky Power denial, we believe Algonquin and AEP will reapply to close the transaction. This expected delay provides Algonquin time to arrange financing to address floating-rate exposure. We anticipate an eventual acceleration of asset sales, but in the near term, we expect variable-rate exposure to be mitigated by new debt issues - potentially a combination of hybrid and term debt.
We believe Algonquin's relative valuation discount is fair given absence of clarity regarding growth prospects. In our view, the recent share price capitulation also reflects investors' concerns over deterioration in the company's earnings base; EPS has arguably been undermined by undisciplined use of equity (i.e., discrete offerings; ATM/DRIP programs; excessive dividend payout ratio) to fund growth.
We are lowering our 12-month target price to $7.50 from $10.00 to reflect a 25% discount to our revised NAV. We reiterate our HOLD rating.
TD Investment Conclusion We expect management to provide a broad strategic update in early-2023 with revised medium-term investment/funding plans and tempered growth ambitions. Management has stated that maintaining an investment-grade credit rating is of paramount importance. We believe a substantial dividend reduction will be a facet of Algonquin's strategic review.