Algonquin Power & Utilities (TSX:AQN) has had its share of highs and lows in the utility sector. Known for its once-reliable dividend growth and strong market position, the stock’s performance has taken a hit over the last couple of years. While it currently offers a 5.4% dividend yield, is it enough to make Algonquin stock a viable investment? Let’s break down the factors that could influence its potential as a buy.
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A history of dividend growth … and cuts
For years, Algonquin was a favourite among income investors. From 2012 to 2021, the company delivered consistent dividend hikes, boasting an average annual growth rate of over 9%. Investors saw their returns multiply, with total returns exceeding 15% annually from 2011 to 2021. By February 2021, the stock had quadrupled in value over the decade, making it a stellar performer in the utility sector.
However, things took a drastic turn in 2022. The rapid rise in interest rates put significant pressure on utility stocks, and Algonquin was no exception. The company’s relatively high debt levels exacerbated the impact of rising borrowing costs, leading to a dramatic re-rating of its stock. In March 2023, the company slashed its dividend by 40%. But that wasn’t the end of the bad news — in August of this year, Algonquin cut its dividend again, bringing the total cut from late 2022 to a staggering 64%.
While the 5.4% dividend yield may seem attractive at first glance, the dividend cuts raise serious questions about the stock’s future dividend reliability. For investors relying on consistent payouts, this uncertainty is a major red flag.
What’s behind its recent struggles?
Algonquin’s troubles began with external pressures, such as rising interest rates. But beyond macroeconomic factors, the company’s strategic decisions have also played a role. Algonquin has been shifting away from its renewable energy operations, focusing instead on its core regulated utility businesses. In August, it announced the sale of its renewable energy assets for up to US$2.5 billion, a move designed to strengthen its balance sheet and position the company for future growth.
This transition, while potentially beneficial in the long run, has led to reduced earnings and cash flow in the short term. Asset sales often come with a decline in revenue generation, and this is one of the primary reasons for the August dividend cut. The company is now more focused on stabilizing its finances and preparing for a potential recovery, which will take time.
Looking ahead, Algonquin’s adjusted earnings per share (EPS) is expected to be US$0.31 this year, putting its payout ratio at around 84%. While this ratio seems sustainable, it is on the higher end, leaving little room for error if earnings disappoint.
Is Algonquin stock a high-risk, high-reward play?
Despite the setbacks, there is some optimism surrounding Algonquin’s future. Analysts believe the stock is undervalued, with a nearly 22% discount at its current price of $6.61 per share, suggesting a potential 12-month upside of more than 27%. If the company successfully completes its transition into a pure-play regulated utility stock, there could be significant price appreciation, making it an intriguing long-term bet.
However, given the stock’s volatile history and the risk associated with its turnaround strategy, investors should be cautious. Algonquin’s shift towards a more conservative utility model and its asset sales might stabilize the company’s fundamentals, but the road to recovery is likely to be a multi-year process. With an investment-grade credit rating of BBB and a focus on recapitalizing its balance sheet, Algonquin is positioning itself for future growth — but the timing remains uncertain.
The Foolish investor takeaway
While Algonquin’s 5.4% dividend yield is enticing, it’s important to consider the company’s recent dividend cuts and ongoing restructuring. For those interested in potential long-term gains, the stock could present an opportunity, but it comes with risks. Investors should wait for the upcoming third-quarter results, set to be released on November 7, to assess the company’s outlook and current financial health before making any decisions.
