Another dividend cut ?
Algonquin Power & Utilities Corp. (AQN-N, AQN-T) US$5.54 | C$7.57 Assessing Potential EPS Impact of Renewable Power Exit
Event
This note provides estimated earnings and dividend payout ratio sensitivities around the potential sale of Algonquin's non-regulated power segment and the company's 43% equity stake in Atlantica Sustainable Infrastructure (AY-US, not covered). We also provide an update for Q3/23 expectations; AQN is scheduled to release results on November 10 before market open.
Impact: POTENTIALLY NEGATIVE
In August, AQN announced its intention to pursue an exit of its nonregulated renewable power segment and focus on the core regulated utility segment. Renewable sector valuations have capitulated since this plan was announced, but we still expect that asset-recycling initiatives are in the company's mid-term plans. AQN is committed to sustaining a BBB credit rating, and differing rating agency parameters for the regulated and non-regulated segments arguably constrain growth potential. Our estimates do not factor-in any asset sales, pending clarity on potential valuation parameters, but, in our view, it is informative to consider the possible mid-term earnings impact.
We expect that an exit of the non-regulated renewable power segment and divestiture of AQN's equity stake in AY would be EPS-dilutive. On a pro forma basis, our 2025 EPS estimate would decline 21% to $0.45. Our estimates are based on a sale of the non-core assets at a 10.0x EV/EBITDA multiple midpoint and selling the AY stake at the current share price. We expect that the net proceeds would be earmarked for a combination of debt reduction and share buybacks.
At our potential estimates, the pro forma dividend payout ratio would be 96% of 2025E EPS. We believe that a payout ratio range of 60-80%, which is in line with the average of North American regulated utilities, would be more reasonable for this company. Recall that AQN lowered its dividend by 40% in Q2/23.
Our HOLD recommendation is unchanged, but we are lowering our target price to US$6.00 from US$8.00. Our lower target price reflects a wider NAV discount and more conservative valuation parameters.
TD Investment Conclusion We reiterate our HOLD rating. In our view, Algonquin's valuation discount is warranted by its compromised earnings base and constraints on attaining strong valuation parameters for its non-regulated business.