Nice Read from Globe and Mail John Heinzel's Opinion
The yield is attractive
Edmonton-based Capital Power currently pays a dividend of 61.5 cents per quarter, or $2.46 annually. Based on the stock price of about $41.75 as of Friday morning, the shares yield 5.9 per cent. That’s good. It’s even better when you consider that Capital Power has raised its dividend for 10 consecutive years, at a compound annual rate of nearly 7 per cent.
And there’s more where that came from. Capital Power typically raises its dividend when it announces second-quarter results, which means investors can expect another increase when the company reports earnings on July 31.
The dividend will continue to grow – just not as fast
At its investor day event in May, Capital Power said it aims to raise its dividend by about 6 per cent annually through 2025, subject to board approval, after which it plans to throttle back the dividend growth rate to a range of 2 to 4 per cent. This will allow the company to allocate more capital to growth projects, while keeping the payout ratio to a conservative 30 to 50 per cent of adjusted funds from operations (a measure of cash flow.)
“I am confident that our dividend guidance is sustainable, and the higher allocation of free cash flow to growth aligns with our long-term value creation and will enhance our overall shareholder returns,” Sandra Haskins, Capital Power’s chief financial officer, said at the investor day.
Demand for power is surging
With a growing portfolio of gas-fired, wind and solar power plants in Canada and the United States, Capital Power produces an essential commodity for which demand is growing steadily. Global consumption of electricity is expected to roughly double by 2050, driven by factors including population growth, wider adoption of electric vehicles and massive growth in data centres – particularly for artificial intelligence – that consume huge amounts of power.
While booming demand will put stress on the aging power grid, it also presents a huge opportunity for electricity generators such as Capital Power.
“We continue to believe CPX is a top idea within our coverage as an AI/data centre play,” Brent Stadler, an analyst with Desjardins Securities, said in a June 5 note to clients. “Within its fleet, CPX has … gas development opportunities as well as the potential to contract merchant exposure in order to meet AI/data centre power demand.”
For the next decade or so, gas-fired generation is expected to be a key source of electricity for power-hungry data centres, with renewables and nuclear contributing a growing share. More generally, gas is expected to be an important transition fuel as the world weans itself from carbon and builds more wind, solar and other renewable infrastructure.
From 2025 through 2029, Capital Power plans to allocate 70 per cent of its growth capital to what it calls “FlexGen,” which refers to gas-fired generation and related energy storage assets. Of the remainder, 20 per cent is targeted to renewables and 10 per cent to other applications.
Falling rates should provide a tailwind
High interest rates are like a ball and chain for power and utilities stocks, for a couple of reasons. First, these companies carry a lot of debt, which means their borrowing costs rise as interest rates climb. Second, because of their bond-like cash flows, power and utilities stocks typically weaken when rates shoot higher, causing their yields to rise in sympathy with the higher yields of bonds.
The good news is that interest rates may finally have peaked, as reflected by the Bank of Canada’s decision in June to cut its policy rate by one-quarter of a percentage point and a recent easing of government bond yields. This week, bond yields dipped again after the U.S. consumer price index slipped 0.1 per cent in June from May – the first monthly drop in more than four years – giving a boost to Capital Power and other interest-sensitive stocks.
Cutting loose from coal
In June, Capital Power announced that its Genesee Generating Station in Alberta is no longer burning any coal, with the plant’s full transition to natural gas generation expected to be completed in the fourth quarter. Apart from doing a favour for the environment, removing the last vestiges of coal from Capital Power’s fleet – and from Alberta’s electricity grid – “should help to increase the investability of the stock,” Mr. Stadler said.
Mr. Stadler added that Capital Power trades at a free cash flow yield (estimated 2024 FCF per share divided by the current stock price) of about 15 per cent, compared with about 9 per cent for similar U.S. companies, “and we believe removing coal should help to narrow the gap.”
Still, the Genesee transition isn’t without risks. When Capital Power released first-quarter results in May, the company raised its cost estimate for the Genesee repowering project to between $1.55-billion and $1.65-billion – up from $1.35 billion in 2023 and its initial estimate of $997-million in late 2020 – citing outages and delays in making the transition to natural gas. Any further cost increases would likely not be received well by the market.
“While the cost increase is disappointing, the company continues to expect this to be a ‘highly accretive’ project,” Maurice Choy, an analyst with RBC Dominion Securities, said in a note
Closing thoughts
Capital Power offers an attractive yield, a well-covered dividend and opportunities for growth as the world consumes more electricity. With some help from lower interest rates, the shares could break out of their recent trading range. In the meantime, I intend to sit back and collect my cash.