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Algonquin Power & Utilities Corp. Faces Uncertain Future with Kentucky Power Acquisition

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Summary
Algonquin Power & Utilities Corp. exceeded Q4-2022 expectations.Capital allocation and 2023 guidance were unsurprising.
Short-term, Algonquin Power & Utilities Corp. stock is unpredictable. Analysts are well offside relative to earnings potential, thus we expect more downgrades in the medium future. Hold/neutral for Algonquin Power & Utilities Corp. As investors know, we exclusively provide sell ratings for shorting. The stock rose after Q4 earnings. Is this the turnaround you’ve been waiting for?

Algonquin Power & Utilities Q4 2022 Earnings
In Q4 2022, AQN beat analyst projections by 22 cents a share. The number exceeded their guidance. Gain on sale predictions were difficult for analysts.The last working day of the quarter finished at 8 cents a share. Thus, the base business earned 14 cents per share. After all three unregulated sectors—wind, solar, and hydro—generated power above long-term averages. Why did baseline profits per share plummet? Interest expense, renewable energy prices, and share count were the main reasons. In Q4-2022, interest expense rose over 55%.If the Kentucky Power transaction goes through, the company’s 2023 interest payments will approach $400 million. AQN’s bottom line remains dominated by interest expense.Algonquin 2023 Guidance AQN maintained its 2023 profits guidance of $0.55-$0.61. That would be a significant drop from the $0.69 reported but still good considering the basic business produced $0.14 in Q4-2022. Other updates addressed the three elephants in the room.AQN wants to sell more assets in 2023 to raise $1 billion. In current market, that is highly optimistic, but we will give management the benefit of the doubt.

The Kentucky Power acquisition is related to the second elephant, Palaeoloxodon Antiquus, which is larger. In 2022, management and dividend groupies were excited about this. What works with rock-bottom interest rates and a limitless share count looks far worse when things are normal. FERC rejected the deal, giving AQN a major break. On Valentine’s Day, AQN submitted a revised application to FERC for approval, but we think everyone hopes FERC sticks to its word and lets AQN leave. April 26, 2023, matters. AQN may leave if the transaction doesn’t close. Management would be foolish to try to make things work beyond that. FERC meets April 20. In exchange for an extension, AQN could cut the acquisition price. This major occurrence will affect equities returns for at least five years.

Capex is the last elephant. We think $3.6 billion is low because it includes the Kentucky Power purchase. AQN has excellent capital discipline, spending $600 million outside of this transaction (provided it goes through). That discipline also implies 2024 earnings will match 2023.

Conclusion
Unfortunately, one event determines our outlook. AQN is doomed for three years if Kentucky Power buys it. In a recession, a debt to EBITDA of 8.0X on 2023 exit is unacceptable. You can speculate that the Fed will cut rates and blow up another bubble. No. Even then, serious economic deterioration will cause valuations to plummet.

If the transaction fails, AQN becomes marginally interesting at these levels. Valuation remains unimpressive. AltaGas (ALA:CA), ATCO Ltd. (ACO.X:CA), TransAlta (TA:CA)(TAC), and Boralex Inc. (BLX:CA) trade lower on EV to EBITDA. At the price we would get long, Brookfield Renewable Partners L.P. (BEP), (BEPC), (BEP.UN:CA) appears quite appealing relative to AQN.

Our conclusion is that investors can include Algonquin Power & Utilities Corp. in a diversified portfolio if they are positive the merger will not go through and are not interested in buying anything better today. We missed the latest rise, but we sold Algonquin Power & Utilities Corp. for roughly twice its current price. We are glad not to be involved and would only contemplate Algonquin Power & Utilities Corp. under $7.00 a share with the Kentucky Power acquisition canceled.

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