“Committed” to the Kentucky Power deal. Management noted that it is focused on re-filing an application with FERC to address its concerns from the December 2022 denial. The company’s capital plan and financing outlook assume the deal closes in April 2023. It sees Kentucky as slightly dilutive to EPS in 2023, and longer-term, mid-single digit accretive to EPS. Kentucky Power was a focus for the call, which is not a surprise given our belief that the market would prefer the transaction to not be completed. Management noted that it continues to use its best efforts to close the deal as required in the purchase agreement. However, we do highlight that the April 26, 2023, outside date for the deal still remains. This is a relatively tight timeline to get FERC approval, which opens the possibility of the transaction being terminated.
Weak 2023 guidance. Management forecasts 2023 EPS of $0.55-$0.61 (not including any asset sale gains), with a midpoint of $0.58. This implies y/y growth of -4% from midpoint 2023E to midpoint 2022E (excluding asset sale gains), which is weaker than we and the market had anticipated. Headwinds to 2023 results include the Kentucky Power delay as well as higher interest costs. As previously mentioned, the renewables segment is expected to be flat on a year-over-year basis. We move down our 2023 EPS estimate to $0.59, which is near the midpoint of the guidance range. Looking into 2024, we also move down our EPS estimate by 17% to $0.62. This represents 5% y/y growth off of 2023 levels. The decline in our estimates is driven by a higher effective tax rate, loss of income related to the $1b of asset sales, and lower overall capital expenditures. Longer term, Management noted that it sees the business potentially growing 5%-8% per annum, though we believe this is more of a 2025 and beyond target
Thoughts on valuation. Algonquin’s business mix (80% utility / 20% renewables) adds complexity when looking at the shares on a P/E basis. As we saw in 2022, the earnings contribution from renewable assets can be lumpy, especially when considering tax attributes. For this reason, we expect investors to look more to EV / EBITDA multiples over P/E multiples when evaluating the stock. On an EV / EBITDA basis, the shares still trade at a discount, though not to the same degree as on a P/E basis. Our $9.00 target price implies an 11.4x EV / EBITDA multiple. This is derived from an 11.5x 2024E EBITDA multiple on its utility business, which implies 1.4x rate base. This would be a discount to Emera’s implied multiple of 13.1x and Fortis at 11.9x. We use a 10.5x multiple on its renewable assets as well as the market value for its Atlantica stake.
Some work to do on the funding plan. Algonquin forecasts capital needs of just under $6b in 2023, with a large majority of spend directed to its Kentucky Power acquisition in addition to debt repayment, capital expenditures, and dividends. The company has narrowed its 2023 capital budget to $1b, which is a 15% decrease compared to 2022 (excluding M&A). Sources of funds include retained cash flow ($0.8b), debt ($1.5b), Kentucky Power debt ($1.2b), and a combination of asset sales, tax equity, and other forms of securitized or subordinated debt ($2.3b). We assume $750m of hybrids are issued mid-2023 as well as $1b of asset sales at the end of 2023. The plan does not include the issuance of any new equity, and it is expected that no new equity will be issued through 2024. The DRIP has also been suspended (effective Q1). A focus of management is to maintain its BBB credit rating, and the credit rating agencies are aware of the financing plan. Adjusting for hybrid debt, we see the company below its 14% adjusted FFO to adjusted debt target in 2023, in part due to the partial year contribution from Kentucky Power. We see the leverage target being achieved in 2024.
Dividend reduced by 40%. The annualized dividend will be reduced to $0.434/sh from $0.7232/sh effective Q1/23, saving the company ~$200m per year. This new dividend level implies a 71%-79% payout range (midpoint of 75%) based on the 2023 EPS guidance, versus our 2023E estimate of 74%. The dividend cut moves the yield from ~10% to ~6%..