AltaGas (TSX:ALA): Should You Buy for the 3.6% Yield?

AltaGas (TSX:ALA) has a 3.6% yield. Is it worth it?

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AltaGas (TSX:ALA) stock has a pretty high dividend yield. At 3.6%, it’s a bit higher than the average TSX stock. It’s certainly not the highest yield out there, but it’s enough to build some cash flow with. When you consider that the company partially operates as a natural gas utility, it starts to get interesting.

Natural gas is rising dramatically this year. Up 100% in Europe and 69% in Alberta, gas is going up even more than crude oil is. It’s a raging bear market in natural gas, and AltaGas is perfectly positioned to capitalize on it. The question is, does that make its stock a buy?

AltaGas’s operations

AltaGas operates in two main business areas:

  1. Midstream (i.e., transmission of natural gas via pipelines)
  2. Utilities (i.e., directly selling natural gas to customers to heat their homes)

Both of these are solid businesses. The midstream business collects fees for transporting a commodity. The utilities business makes money from customers’ gas bills. AltaGas is a regulated utility, which means that the fees it charges to customers require government approval. So, it doesn’t fully capture the revenue you’d imagine looking at the price of natural gas. Nevertheless, its recent results have been pretty good.

In its most recent quarter, it did $0.12 in earnings per share (up 50%) and $0.60 in funds from operations per share (up 7.14%). Funds from operations is a measure of how much cash a company’s day-to-day operations produce. The fact that it grew in the second quarter is a good sign. Not all utilities are experiencing growth this year, but AltaGas is. So, it’s in a good place right now.

Is the payout sustainable?

Having looked at the basics of its business, we can now look at AltaGas’s dividend up close.

In its most recent quarter, AltaGas did $0.12 in earnings per share. Its reported dividend for the period was $0.265. The company is paying more in dividends than it is bringing in in earnings. On the surface, this doesn’t look too sustainable. However, the company also has $0.60 in funds from operations per share.

If we use funds from operations instead of earnings, then we get a payout ratio (i.e., dividends as percentage of profit) of 44%. That’s not only sustainable but actually on the low end for a utility company.

Foolish takeaway

Ultimately, AltaGas is a classic utilities stock. Although it partially functions as a pipeline company, its main business is selling natural gas to help people heat their homes. In that regard, it is a success.

Few utilities deliver truly phenomenal growth; AltaGas’s 50% earnings growth is above average for its sector. The 7% growth in funds from operations is underwhelming for an energy company in 2022, but remember, AltaGas is not the kind of energy company most people think of when they hear the term. By the standards of a pipeline or a utility, AltaGas’s performance has been satisfactory this year.

AltaGas’s dividend looks unsustainable on the surface of things. The company is paying out approximately double its earnings in dividends every quarter. That looks dicey, but remember that its cash flow-based payout ratios are much better. Taking everything into consideration, I’ll pass on this stock, but it might merit a place in a diversified utilities portfolio.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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