RBC -price Target increase to $17. (U.S.$)"Algonquin Power & Utilities Corp.
Capital deployment continues;
raising price target to $17
Our view: We reiterate our Outperform rating and raise our price target to $17 (from $15), as we believe the shares of Algonquin offer a good balance of growth, income, and exposure to renewables. At its upcoming investor day, we expect the company to refresh its 5-year growth trajectory, which historically has been ~10%+ EPS growth without new acquisitions.
Key points:
Capital deployment continues despite some COVID-19 delays. During the quarter, Algonquin placed 275 MW into service, and it expects to reach completion on another 850 MW by year-end. Some of the 600 MW of wind capacity in the Customer Savings Plan will be completed in Q1/21. In the regulated utility division, Algonquin acquired a 94% interest in the Chilean water company (ESSAL) and a 100% interest in Bermuda Electric and Light Company (BELCO) in Q4/20. Management remains optimistic that it can close the pending acquisition of water assets in New York State, and it welcomes the public discussion on whether water assets should be owned by municipalities. Algonquin believes that it is best positioned to provide essential water services to customers.
Upcoming investor day should tally up the puts and takes on its growth initiatives. Management will be host its annual investor day on December 14 virtually. There have been some new investments (e.g., ESSAL) and setbacks (e.g., Granite Bridge), but we see additional investment opportunities from greening BELCO’s grid and enhancing water resource and resiliency at ESSAL. Finally, we believe that management may address its dividend growth outlook next month (rather than in 2021) given the change in senior management this year.
Raising estimates and rolling out our 2022 forecast. We raise our 2020 and 2021 EPS estimates to $0.65 and $0.74, respectively, to primarily reflect higher-than-expected Q3/20 results and updated timing for projects under development. Our 2020E EPS is consistent with management’s expectation that it will be at the lower end of its EPS guidance of $0.65–0.70. We introduce our 2022 EPS forecast of $0.81, which reflects the expected commissioning of several wind developments, the full-year contribution from the pending water acquisition in New York State, and continued rate base growth.
Raising price target to $17. We raise our price target to $17 (from $15) to reflect our view that the company has a long runway for growth and that a Biden administration will likely have a positive net impact on the company, particularly on its U.S. renewable development pipeline. Our price target is derived using a sum-of-the-parts valuation with an implied EV/EBITDA multiple to our 2022E (previously 2021E) EBITDA of roughly 14x (previously 13x) and an implied 2022 P/E multiple of 21x.
Price target/base case Our base case price target of $17 is derived using a sum-ofthe-parts valuation with an implied EV/EBITDA multiple to our 2022E EBITDA of roughly 14x. The implied valuation multiple is a slight premium to the peer group due to Algonquin’s attractive growth profile.
Upside scenario Our upside scenario value of $19 assumes that Algonquin successfully builds investor support for its international investment, executes its capital plan, and announces new accretive acquisitions over the next several years. Our sum-ofthe-parts valuation implies a 15x EV/EBITDA multiple to our 2022E EBITDA.
Downside scenario Our downside scenario value of $10 is based on the assumption that long-term interest rates increase significantly (e.g., 200-300 basis points), potentially making development projects uneconomic, and significantly capping Algonquin’s growth profile. Our sum-of-the-parts valuation implies a 10.5x EV/EBITDA multiple to our 2022E EBITDA.
Investment summary
We expect Algonquin shares to outperform peers for the following reasons:
1. The right foundations to continue growth strategy: The company has a strong development pipeline in the renewable energy sector, and it has built up a regulated utility business that can grow organically or through acquisitions. The company is actively developing renewable energy within its regulated footprint (greening generation fleet) as well as on a non-regulated basis (contracted or hedged).
2. Reasonable dividend with room to grow: The current dividend yield is approximately 4%, and the dividend has grown at 10% annually for the past ten years. We expect the future dividend increases will be in the high single digits.
3. Favourable ESG profile. The company has a large renewable energy footprint and has reduced the carbon intensity of its regulated utilities. The company also scores well on a sustainability and governance perspective, which makes the company attractive to a broad range of investors.
4. Attractive valuation: We believe the shares are attractively valued based on our price target of $17 and a dividend yield of ~4%.
Q3/20 results above expectations
Algonquin Power’s Q3/20 Adjusted EPS of $0.15 was above our estimate of $0.12 and consensus of $0.14. Adjusted EBITDA of $186 million (excluding $12 million of HLBV income) was largely in line with our estimate of $183 million. The variance to our estimate was largely due to higher contribution from the Regulated Distribution segment and lower-thanexpected overhead and depreciation costs, partially offset by lower-than-expected contribution from the Generation segment (production was 9% below average). Management reiterated its 2020 Adjusted EPS guidance of $0.65–0.70 and continues to expect to finish the year around the lower end of the range.
Other highlights from the quarter
Cost-savings initiatives offset impacts of COVID-19. Management noted that the COVID-19 pandemic and resulting business suspensions and shutdowns have caused a decrease in consumption among certain commercial and industrial customers. As a result of the decreased demand, the company estimates that the Regulated Distribution segment’s Operating Profit was negatively impacted by $4.2 million and $14 million in Q3/20 and over the last nine months, respectively (equating to Adjusted EPS of -$0.01 and -$0.02, respectively). In response to the unfavorable weather variance in Q1/20 and the impacts from COVID-19, management implemented cost-containment strategies. Over the last nine months, the company achieved ~$18 million in cost savings, and management expects to achieve a further $5–10 million in Q4/20.
Bermuda Electric (BELCO) and Chilean Water (ESSAL) acquisitions completed. As previously announced, Algonquin completed the $365 million acquisition of BELCO on November 9 and the $162 million Chilean water (ESSAL) acquisition on October 14. Management noted that it is continuing discussions with the government of Bermuda and hopes to be able to execute on some greening of the fleet initiatives beginning in the 2021 time frame.
Commissioning 245 MW of solar and wind. The company commissioned the 43 MW Great Bay II solar project in southern Maryland (August 13) and the 202 MW Sugar Creek wind project in Illinois (November 9). Both projects are underpinned by long-term financial hedges while RECs from the Sugar Creek wind facility will also be sold under long-term contracts to utilities in the state.
Decreased capital investment for the Granite Bridge project. Regarding the Granite Bridge project, management noted that new pipeline capacity became available in the region, which has decreased the scope of the project. The Granite Bridge project is an infrastructure project designed to bring natural gas supply from existing infrastructure located in New Hampshire’s Seacoast region to residents and businesses in the central part of the state through an underground pipeline. Originally, the project represented a potential investment of $320–360 million. Management believes that there is still quite a bit of investment required to strengthen reliability of the system, but the scope of the capital investment has decreased from its original plans.
Continues to expect acquisition of New York American Water to close in 2021. Regarding the pending $608 million acquisition of American Water’s regulated operations in New York State, management noted that it remains engaged with the public utility commission and other stakeholders, and it continues to expect the transaction to close in 2021.
Potential to acquire the other 50% interest in AAGES. With respect to the international development vehicle AAGES, management noted that it acquired an option to buy out Abengoa’s (currently going through a restructuring) 50% interest in the joint venture. Management noted that AAGES has a development pipeline that includes solar developments in Spain and a 20 MW solar project in Colombia that is under construction and set for commercial operations in Q1/21. We expect management to provide additional details on its plans for the future of AAGES and its international growth strategy at the upcoming investor day in December.
Revising estimates and rolling out our 2022 forecast
We raise our 2020 and 2021 EPS estimates to $0.65 and $0.74, respectively, primarily to reflect higher-than-expected Q3/20 results and updated timing for projects under development. Our 2020 EPS is consistent with management’s expectation that it will be at the lower end of its EPS guidance of $0.65–0.70. We introduce our 2022 EPS forecast of $0.81, which reflects the expected commissioning of several wind developments, the fullyear contribution from the pending water acquisition in New York State, and continued rate base growth.
Valuation
Our base case price target of $17 is derived using a sum-of-the-parts valuation with an implied EV/EBITDA multiple to our 2022E EBITDA of roughly 14x. The implied valuation multiple is a slight premium to the peer group due to Algonquin’s attractive growth profile. We believe that the risk-adjusted total return to our price target supports our Outperform rating on the shares.
Risks to rating and price target
Factors that could negatively impact our price target and rating include negative regulatory decisions by the U.S. regulatory commissions, an acquisition that fails to gain the confidence of investors, depressed prices for power in the U.S. Northeast, and a sustained decline in the U.S. dollar, and lower results than forecast due to demand and/or pricing related to COVID-19."