Any time a dividend yield moves above the 8% mark, investors have to ask themselves why the distribution is so high before deciding to invest.
Above-average yield triggered by a drop in the share price often signals a lack of market confidence in the company’s ability to maintain the payout. The story has played out time and again, and while some opportunities turn out to be real bargains, others result in big losses for shareholders when the distribution is eventually cut.
Let’s take a look at AltaGas Ltd. (TSX:ALA) to see if it deserves to be in your dividend portfolio today.
AltaGas recently closed its $9 billion purchase of Washington, D.C.-based WGL Holdings. The deal wasn’t popular with the market, as analysts questioned the price tag and debated whether AltaGas was biting off more than it can chew.
The fact that the company managed to close to purchase is a good sign, although some of the debt concerns continue to put pressure on the stock. AltaGas had to take a US$2.3 billion bridge loan to close the acquisition. Over the past year, management tried to sell some non-core power assets in the United States but couldn’t find a buyer willing to pay enough. In June, AltaGas sold a 35% interest in its North West British Columbia hydroelectric facilities for $922 million. The funds helped reduce the amount of money the company had to draw on the credit facility.
AltaGas expects to repay the bridge loan quickly using funds from additional asset sales and the offering of hybrid securities and senior debt. Investors should get an update on the process when AltaGas reports its Q2 earnings on August 1.
Debt concerns aside, the WGL deal should be positive for shareholders. AltaGas adds a high-quality natural gas distribution utility with cash flow coming from regulated, low-risk assets with a rate base of $4.5 billion. AltaGas intends to grow the rate base to $7 billion by the end of 2021.
This should provide adequate cash flow growth to sustain the current distribution. Investors might even receive a payout increase. Management previously indicated the company could deliver dividend hikes of at least 8% per year for 2019-2021.
Shareholders will have to see what comes out of the Q2 report regarding the dividend outlook. AltaGas recently reported the sudden resignation of CEO David Harris due to a complaint received by the company’s board of directors. Two interim co-CEOs are now running the company, including AltaGas founder and chairman David Cornhill.
When the leadership changes at a company, decisions on how to allocate cash can shift.
AltaGas pays a monthly distribution of $0.1825 per share. That’s good for a yield of 8.3% at the time of writing.
Should you buy?
AltaGas has $6 billion in identified growth opportunities, and the company’s Ridley Island Propane Export Terminal is nearing completion, so the revenue and cash flow outlook should be solid.
Once the company gets the bridge loan paid off, investors could start to move back into the stock in a meaningful way. As such, it might be worthwhile to start a contrarian position while the company is still out of favour.
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Fool contributor Andrew Walker owns shares of AltaGas. AltaGas is a recommendation of Stock Advisor Canada.