Shares of capital-intensive companies such as Innergex Renewable (TSX: INE) are trading significantly below all-time highs. In the last 20 months, central banks have hiked interest rates at an accelerated pace to offset elevated inflation levels. However, the increase in the cost of debt has raised interest expenses for debt-heavy companies, reducing profit margins and cash flows in recent quarters.
Due to lower earnings, share prices of clean energy companies such as Innergex Renewable are trading at depressed valuations, increasing their dividend yield in the process. For instance, INE stock is down 73% from all-time highs, increasing its dividend yield to a tasty 8.3%.
However, investing in a company based solely on its dividend yield is quite risky as these payouts are not guaranteed. In the last few months, several TSX companies, such as Algonquin Power & Utilities and Northwest Healthcare REIT, were forced to reduce their dividends by more than 50% due to their unsustainable payout ratios amid rising interest rate hikes.
So, let’s see if the dividend payout of Innergex Renewable is safe right now.
Is Innergex Renewable stock a good buy right now?
Valued at a market cap of $1.8 billion, Innergex Renewable is one of Canada’s largest renewable energy companies. It has built a diversified portfolio of high-quality, long-lasting assets within hydro, wind, and solar energy verticals. Innergex Renewable aims to develop and acquire facilities that offer an attractive risk-adjusted return on invested capital.
With an installed capacity of 4,266 megawatts, Innergex Renewable is a 100% renewable energy project developer with a focus on North American markets. It has 85 operating facilities with 13 projects under development. These projects are typically secured under long-term power purchase contracts, allowing Innergex to benefit from a steady stream of cash flows across market cycles.
In the last eight years, the company has more than tripled its power-generating capacity from 1,209 megawatts, which has increased earnings and cash flows. Due to its predictable cash flows, Innergex Renewable has increased its dividends by 25% in the last 13 years.
Innergex Renewable has a payout ratio of 127%
Innergex Renewable ended the second quarter (Q2) with $6 billion in debt and just $130 million in cash. The company needs to generate enough cash flows to pay shareholders a dividend, reinvest in capital projects, and strengthen its balance sheet over time. Generally, a dividend-payout ratio of less than 70% provides capital-intensive companies with enough flexibility to pursue these goals.
However, Innergex ended Q2 with a free cash flow of $115.3 million compared to $173.64 million in the year-ago period. Its payout ratio widened to 127% in Q2 from 82% in the year-ago period, making investors wary and resulting in a drawdown in share prices.
The Foolish takeaway
It’s quite evident that Innergex will have to reduce its cost base and drive future cash flows higher to improve the payout ratio and maintain its dividends. Analysts tracking INE stock expect its bottom line to improve to adjusted earnings of $0.29 per share in 2023 from a loss of $0.17 per share in 2022.
Priced at 30 times forward earnings, INE stock is trading at a premium to the TSX index. But analysts remain bullish and expect shares to almost double in the next 12 months.
