Algonquin Power & Utilities Corp. (TSX:AQN) is the dividend stock that nose-dived in October 2022 as it felt the pressure of rising interest rates. Utilities is one of the safe dividend sectors, as there is always demand for electricity, water, and natural gas. Then why did the stock crash by 40%?
Why did Algonquin stock crash?
Algonquin has significant debt of $8.5 billion, of which 15% is variable. In 2022, the debt was $7.7 billion, and the variable component was 22%. The rising interest expense pushed Algonquin into losses in 2022, forcing the company to slash dividends in early 2023 and undertake restructuring. It also cancelled all acquisition plans as the priority shifted from expansion to sustaining business operations amid losses.
Losses are critical for a company with high debt, as it should service its debt. It leads to cash burn. Such a situation is not sustainable in the long term.
As interest rate hikes continued in 2023 with no signs of rate cuts, the company changed its CEO and decided to sell its Renewable Energy Business, where the power generation is dependent on weather conditions.
While the sale of the Renewable Energy Business is still in process, Algonquin has managed to turn profitable, reporting a net profit of $28.7 million in 2023 from a loss of $212 million in 2022. The company’s interim CEO, Chris Huskilson, expects to finalize the sale of the renewable energy business by late 2024. The renewable energy business accounts for 12% of Algonquin’s revenue and 19% of net income.
The new Algonquin will be a pure-play regulated utility with greater operational efficiency. It plans to grow its business based on the regulated rate of electricity, water, and natural gas. With the sale of renewable energy, volatility around earnings will vanish, making the earnings more predictable.
Is Algonquin stock a good investment?
The sale of the renewable energy business, cost optimization, debt reduction, and rate-based growth could stabilize Algonquin’s future earnings. If we compare the stock’s valuation with a pure-play utility company like Canadian Utilities, Algonquin is slightly riskier even though it trades lower. Canadian Utilities stock is trading at 13 times its upcoming 12-month earnings per share, while Algonquin stock is trading at 12 times. However, Algonquin offers a slightly higher dividend yield of 6.78% compared to Canadian Utilities 5.86%. It would be fair to say that the market has priced in the risk in Algonquin’s stock.
Algonquin has made remarkable progress in returning to profitability. Its utility business has been doing well even in difficult times. The announcement of the sale of the renewable energy business and interest rate cuts could drive the stock price upwards. Those who bought the stock in 2022 and are sitting on a 40% negative position might be wary of buying into the stock. But it is a good investment now as the fundamentals have improved.
Any business goes through ups and downs, and that is what strengthens its operations. It is only in downturns that the sustainability of a business is tested. The worst seems to be over for the company. If you expect the interest rates to ease soon, Algonquin could be a good stock to buy for a recovery rally.
Investor takeaway
If you already own Algonquin stock, holding it would be a better option than selling it for a loss. However, you can minimize your losses by buying more shares and reducing your cost per share. This dollar-cost averaging can help you recoup losses at a faster rate. Its utility business could continue giving out dividends for years to come, although I won’t be optimistic about dividend growth.
