Opinion Independent Reports Dividend seekers, don't miss this...

Dividend seekers, don't miss this profitable and overlooked yielder from the utilities sector

Nathan Kirykos, Seeking Alpha alias: Value Digger

0 Comments| October 30, 2017

I always love shedding light on little-known stocks with healthy balance sheets both for value investors and income seekers. And I believe that Valener Inc. Series A Preferred (TSX: VNR.PR.A) fits the bill and should be included into a Dividend Investing Portfolio given also thatthis preferred stock currently trades under its par value of C$25.

Investors can't find articles about Valener and its preferred stock on the popular financial websites, which made me write an article about this underfollowed and consistently profitable company.

Assets Overview

Valener is a Canada-based electric and gas utility holding company that was created in Oct 2010 to replace the Gaz Metro Limited Partnership public investment vehicle (TSX: GZM.UN-T). Its assets are a 29% direct interest in Gaz Metro and a 24.5% indirect interest in Seigneurie de Beaupre Wind Farms which is one of Canada's largest producers of wind power (340 MW contracted), as shown below:

Gaz Metro operates in the electricity production market and the electricity and natural gas distribution market and it's involved in developing renewable, liquefied and compressed natural gas, solar and wind power and hydroelectricity.

Actually, Gaz Metro is a major player in Quebec and Vermont. It's the largest natural gas distribution company in Québec, where its network of over 10,000 km of underground pipelines serves more than 300 municipalities and more than 205,000 customers (residential, commercial, industrial).

Also, it has more than 315,000 customers in Vermont, where it's both the largest electricity distributor (over 265,000 customers) with market share of 80% and average yearly growth of 6% and the sole natural gas distributor (over 50,000 customers) with estimated annual growth of 0.8% over the next years thanks to the expansion to Addison County, as shown below:

and below:

Given also that the company's regulated assets increased from 95% in 2006 to 97% in 2016 and its asset exposure to U.S. energy distribution went from 5% in 2006 to 50% in 2016, we can draw the conclusion that this is a stable, highly predictable and largely diversified business.

Strong Cash Flow And Free Cash Flow With Low Leverage

Credit facility and debt: In March 2017, Valener extended the maturity of its credit facility to March 2022 with the maximum authorized amount being C$200 million. In June 2017, the amount drawn on the credit facility was approximately C$112 million leaving ample liquidity and an unused portion of approximately C$88 million. Meanwhile, the company's cash was under C$1 million resulting in net debt of approximately C$111.5 million at the end of the third quarter.

The credit facility is secured by Valener's units in Gaz Métro and its shares in Valener Éole and bears interest at floating rates based on the bankers' acceptance rate or the prime rate, adjusted according to the terms of this credit facility. The effective interest rate for the fiscal year ended September 2017 remained low at 1.7%. For reference, it was 1.74% and 1.77% in FY 2016 and FY 2015 respectively.

The long-term debt is subject to restrictive covenants requiring it to satisfy certain financial ratios or conditions at all times. Among other things, on a non-consolidated financial statements basis, the company must satisfy an interest coverage ratio of at least 3.00 times and a ratio of long-term debt to the total distributions and dividends received less general and administrative expenses of less than 4.25 times. Valener has been in compliance with all of the conditions of its credit facility over the last years with these two ratios being above 30 times and under 2.5 times respectively, as shown below:

Adjusted EBITDA and leverage: Adjusted EBITDA in FY 2016 was approximately C$80 million. After taking into account the results to-date, I project that adjusted EBITDA in FY 2017 will remain at the same levels reaching approximately C$80 million. As a result, the net debt to adjusted EBITDA ratio will remain in safe territory andunder 1.5 times in FY 2017.

Cash flow and dividend: The company is a cash flow and free cash flow generator. In the first nine months of FY 2017, operating cash flow was C$41.2 million, while cash flow used in investing activities was C$36.9 million due to two non-recurring items in Q1 2017.

Specifically, on March 31, 2017, Valener subscribed, in proportion to its current interest in Gaz Métro, for 1,318,291 Gaz Métro units for a total cash consideration of C$29 million. Moreover, during fiscal 2015, Valener entered into swaps for a total nominal value of C$44.8 million with a mandatory early termination date in October 2016, to cover the risk of interest rate fluctuations on an initially planned debt issuance. Since these swaps didn't meet the conditions for hedge accounting, changes in fair value were therefore recognized in income. These swaps were settled for C$7.8 million in October 2016.

Excluding these two non-recurring items, Valener generated free cash flow of approximately C$41 million for the nine months of FY 2017. And I project that it will generate free cash flow of approximately C$56 million in FY 2017.

Given that the dividends to common and preferred shareholders will total approximately C$43 million in FY 2017, the aforementioned free cash flow is more than enough to cover the dividends resulting in a payout ratio under 80%. As such, Valener will also have the opportunity to use the remaining free cash flow and reduce its bank debt in the coming quarters.

For reference, operating cash flow was C$56.7 million, while cash flow used in investing activities was less than C$1 million in FY 2016. Therefore, Valener generated free cash flow of approximately C$56 million in FY 2016, which was again more than enough to cover the annual dividend payments to the common equity and preferred holders.

Dividend Growth For The Common Stock Bodes Well For The Preferred Stock

It's noteworthy that Valener has consistently increased the dividend for the common equity holders over the last years as a result of its excellent financial health.

Specifically, the annual dividend per common share was C$1 in FY 2014, C$1.02 in FY 2015, C$1.07 in FY 2016 and C$1.12 until August 2017, when the company announced another increase in the annualized dividend from $1.12 to $1.16 per common share.

This continued YoY growthtranslates into approximately 4% CAGR. More importantly, Valener has set a goal of achieving compound annual dividend growth of 4% for the common equity until 2022, according to the CEO, as shown below:

This dividend growth plan associated with the common equity bodes well for the Preferred holders who rank senior to the common equity holders. Since Valener aims to hit a 4% CAGR until 2022 for the common dividend, potential problems associated with the payment of the dividend for the Series A Preferred stock until 2022 are eliminated. This is common sense.

On that front, Valener has 4 million Series A Preferred shares outstanding that were issued in June 2012 and rank senior to the common equity. The Series A Preferred shares were paying cumulative dividends of C$1.0875 per share per annum, payable quarterly, for the initial period that ended on October 15, 2017.

The dividend rate is being reset every five years and was reset on October 15, 2017 at a rate equal to the five-year Government of Canada bond yield plus 2.81% that translated into 4.62%. This interest rate will last until October 15, 2022.

As expected, Valener didn't redeem the Series A Preferred stock at par on October 15, 2017 because it didn't afford to redeem it. Actually, Valener would need C$100 million in cash to redeem it. And given that it didn't have this cash, it didn't want to borrow money and max out its credit line.

Takeaway

Valener's Series A Preferred shares are for risk-averse income seekers in the Utilities sector. Currently, they stand at C$23.20 and their interest rate will be 4.62% until October 15, 2022. Also, it's very likely that the stock will come closer to the par value of C$25 and therefore, the holders will make an additional 8% by October 2022. This scenario isn't wishful thinking. This scenario is very likely thanks to Valener's balance sheet and free cash flow that are estimated to remain strong in the foreseeable future.

If you like this article and look for deep value ideas that are potential multi-baggers along with dividend plays, consider signing up for Value Investor's Stock Club. Members get exclusive access to our best ideas on unknown or underfollowed companies that are potential multi-baggers, as well as dividend ideas with 7%+ yields, trade alerts for when we close positions, and an active chat room to stay ahead of the crowd. Check out why our subscribers have given unanimously 5 star ratings and outstanding reviews.

Disclaimer: The opinions expressed here are solely my opinion and should not be construed in any way, shape, or form as a formal investment recommendation. Value Digger does not accept any liability for any loss or damage whatsoever caused in reliance upon such information. Investors are advised that the material contained herein should be used solely for informational purposes. Investors are reminded that before making any securities and/or derivatives transaction, you should perform your own due diligence. Investors should also consider consulting with their broker and/or a financial adviser before making any investment decisions.

Disclosure:I'm long VNR.PR.A. I wrote this article myself, and it expresses my own opinions. I'm not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.