Algonquin Stock Has Risen 28% This Year, But Is it Safe for Investors Today?

Algonquin stock can still be a decent investment over the next year, but there are higher-quality utility stocks that investors can explore.

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Algonquin Power & Utilities (TSX:AQN) stock lost a lot of altitude during 2022. From peak to trough, the stock lost more than half of its value. This is a good illustration of how common stocks can destroy shareholder value. However, to be fair to Algonquin, it wasn’t the only stock that sold off significantly in 2022.

Higher interest rates

Rising interest rates last year was a big factor in the stock market selloff. To combat inflation that was rising too fast, the Bank of Canada raised the policy interest rate swiftly along with other central banks around the world like the Federal Reserve in the United States. The inflation in Canada peaked in June 2022 at 9.1% and has headed down since, but, at 5.2% in February, it was still relatively high versus the Bank of Canada’s target of about 2%. So, the Bank of Canada is unlikely to cut interest rates anytime soon.

Higher interest rates increased the cost of capital for businesses. Therefore, this environment is, generally, a drag on business growth.

Furthermore, Algonquin has a poorer balance sheet versus larger utilities. Currently, its S&P credit rating is BBB. Although this is an investment-grade credit rating, investors can easily find higher-quality utilities with credit ratings of BBB+ or better.

The Kentucky Power acquisition

Some investors did not like Algonquin’s pursuit of Kentucky Power since late October 2021. For example, Robert Hope, a Scotia Capital analyst with the CFA designation wrote, “[The] investor sentiment is that if Kentucky Power were to fall through, Algonquin’s balance sheet would be stronger, which would be supportive of a higher valuation.”

What’s worse is that this acquisition has dragged on as the U.S. regulator FERC denied the transaction in mid-December 2022. The longer this takes, the more resources may be used on Algonquin’s part.

Dividend cut

Combining a rising interest rate scenario and the negative investor sentiment on the Kentucky Power acquisition, the stock experienced a landslide with the stock down approximately 45% from September to December 2022. Furthermore, investors were also rightly pricing in for a dividend cut, which finally came slashing in in March 2023.

I would like to point out that the stock hit the bottom in late December 2022. By the time the dividend cut occurred, the stock had already rallied about 20% from the bottom. This goes to show that stock investing is forward looking. Year to date, the stock has appreciated just north of 28%, as the value stock became too cheap to ignore in late December 2022.

AQN Chart

AQN data by YCharts

Is it safe to invest in Algonquin stock today?

There are higher-quality utility stocks that investors can explore. However, Algonquin stock could still be a decent investment over the next year.

According to the analyst consensus 12-month price target, Algonquin stock trades at a discount of almost 10%. In other words, it has near-term upside potential of approximately 11%. The dividend stock also offers a dividend yield of almost 5.2%. Algonquin’s going forward payout ratio is estimated to be roughly 70%. So, it should be able to sustain its dividend. In other words, it can potentially deliver total returns of about 16% over the next 12 months.

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 Kay Ng has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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