A stable capital gains profile in combination with a reliable and bankable dividend payout can be an income investor’s dream, and very high premiums are usually payable for such high-quality stocks. However, there can be some rare gems on the TSX, and AltaGas Canada (TSX:ACI) is a fresh listing that one will kick themselves for not scooping.
The company is a spin-off from troubled North American energy giant AltaGas, and it went public in October last year, as the mother company sought to improve its liquidity position after an overly ambitious $9 billion WGL acquisition that closed mid-year 2018.
The recently listed utility company has three natural gas distribution facilities serving Alberta, British Columbia, and Nova Scotia that provide about 88% of the company’s cash flows, with the balance contributed by renewable energy assets.
There has been a strong and sustained rally in the emerging income-growth stock, which traded up over 34% since its October 2018 IPO, and shares are exchanging hands at prices 20% firmer on a year-to-date basis.
The share price may have rallied already, but there’s still some value to be gained from an investment in the units, even as its valuation multiples rise towards that of its few comparable peers with highly regulated, stable growth and reliable, secure cash flows.
Why a great buy?
The stock pays a well-covered $0.24-per-share quarterly dividend that yields a reliable 4.9% annually. There is a great promise for healthy annual dividend-growth rates ahead, and the new listing actually started off 2019 with an impressive 36% quarterly dividend increase. I would expect some more increases over the coming years, as the company grows its cash flows.
Speaking of growth, there’s an impressive growth outlook in the company’s core business in the near term. Management has committed to a solid and fully funded five-year, $330-million-growth capital-expenditure plan that aims achieve a 5% compound annual increase in utilities rate base to over a billion by 2023. The base rate stood at $879 million by March 31.
I attach a very low execution risk on the growth capex plan, as the company has a highly experienced management team that retained leadership positions after the break off from the parent.
Although first-quarter 2019 after-tax net income was marginally lower than it was in 2018 due to slightly higher operating and administrative expenses, the company had a very strong and impressive start to the new year.
On May 8, management reported a 5% year-over-year growth in utilities earnings for the first quarter of 2019, driven by a colder weather and, most importantly, higher approved rates. I like the recent improvement in internal profitability, where a normalized net income of $0.68 per share for the quarter was a healthy 9.7% higher than same period performance in 2018.
Most importantly, normalized funds from operations, at $1 per share, came in 9% higher than a comparable reading in 2018, and I expect some mid single-digit cash flow growth rates to persist as current growth plans are executed.
Asset-base-wise, the company is still very small today, especially as compared to its subsidiary days. Any small growth initiatives within the business have a much greater impact on the smaller capital base now, and investors could enjoy further and better capital gains than before.
Some issues to consider
If interest rates continue to firm up in the long term, leverage can be an issue, as the company had a high net-debt-to-total-capitalization ratio of 50.7% by the end of March this year.
However, management recently managed to lock up a significant portion of the debt at a 3.15% interest over the next five years after closing a new $250 million medium-term notes in April this year and used the proceeds to pay down debt. The current growth plan is funded largely from internally generated cash flows, so I wouldn’t be concerned about increasing leverage.
Investors should take notice of a potential selling pressure later this year, as the one-year lock-up period on AltaGas’s 45% stake expires around October. The parent may easily decide to dispose some shares to prop up its liquidity, as it can manage to lower its position to 30% and still retain all its current board seats and influence in the company.
It would be a great opportunity to load up more shares should there be any price weakness on the high-quality stock.
