When it comes to utilities, investors expect a rich dividend.
Its annual payout of US$0.466 per share is good for a 5% yield for Canadian investors, as the U.S. dollar has been strengthening against the Canadian dollar. The high yield is secured by the company’s stable cash flow generation and a conservative payout ratio.
What fuels Algonquin’s cash flows is its diversified portfolio of rate-regulated distribution utility and power-generation assets.
Other than a juicy dividend, Algonquin also offers stable growth. The diversified North American utility reported promising fourth-quarter and 2016 results on Thursday and has growth plans through 2021.
In 2016, Algonquin generated nearly $1.1 billion of revenue, which was 7% higher than the previous year.
Additionally, its adjusted funds from operations per share and adjusted earnings per share increased by 14.5% and 24%, respectively.
The successful acquisition of Empire District Electric at the start of the year and the recent addition of newly constructed renewable electric generation of 360 MW are expected to help Algonquin deliver record earnings in 2017.
Five-year growth plan
Empire is a big part of Algonquin’s growth plan through 2021. It added about 218,000 distribution customers to Algonquin’s portfolio. In total, Algonquin now has regulated utility operations in 13 states, serving more than 782,000 gas, water, and electric utility customers. The bigger portion of regulated earnings implies a safer dividend.
Excluding Empire, Algonquin has $5.4 billion of potential investments (about 44% for its power-generation portfolio and 55% for its regulated utilities) over the next five years.
Algonquin’s rate-regulated utilities and power generation, which are largely under long-term contracts, generate stable cash flows for its dividend.
Algonquin pays out less than 40% of its funds from operations as dividends. The remaining cash flow is reinvested into the business for growth.
With Algonquin’s strong cash flow generation, it’s no wonder that management had the confidence to hike its dividend by 10% in the first quarter.
That marks the beginning of its seventh consecutive year dividend hike. In fact, management aims to hike its dividend by 10% per year as far out as 2021.
Valuation and expected returns
At about $12.50 per share, Algonquin trades at a price-to-earnings ratio of about 23 and a price-to-cash flow ratio of roughly 11.
These are reasonable valuations for the double-digit growth that the utility has been experiencing. Management anticipates its earnings and funds from operations to grow north of 10% per year on a per-share basis.
The 12-month mean price target across 12 analysts at Reuters is $13.70. So, an investment in Algonquin today can return about 14% in the next year.
Algonquin has had a nice run-up since November. However, it’s still a reasonable buy for double-digit returns and a 5% yield. If the shares dip below $11, it’d be a strong buy.