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Why I’m not giving up on Algonquin Power

John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.

Over the past couple of years, Algonquin Power & Utilities Corp. has at times given investors a bumpy ride.

Back in 2013, for example, the shares – already under pressure from rising bond yields – plunged after an independent research firm slapped a "sell" on the stock. Accountability Research Corp. cited "related-party transactions" and warned of "considerably high execution risk in terms of the company's recent acquisition spree."

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Fortunately for investors (of which I am one), the damage was short-lived and the shares went on to post a total return – including dividends – of about 37 per cent in 2014.

But the drama wasn't over yet.

In March of this year, the shares skidded again after Algonquin delayed its fourth-quarter results amid what it called "anonymous, unproven allegations" relating to certain Algonquin "personnel" and the company's "financial reporting and related practices."

Although the company never disclosed the precise nature of the complaints, when it released the results it assured analysts that a committee of independent directors had looked into the financial allegations and concluded that nothing was amiss. That part of the investigation was now closed, it said, but it continued to investigate non-financial allegations concerning "the workplace and its environment."

Certainly, investor confidence in Algonquin has taken a hit. The shares have rebounded from their March lows but are still well back of their January high of $10.51. On Tuesday, they closed at $9.66, up 8¢. Evidently, some investors are still wary.

However, there are also reasons to be optimistic about Algonquin's future. For all the anxiety that Algonquin's shares have inflicted on investors, the company has many strengths that could play in its favour over the long run. Here's why I haven't given up on the stock.

The dividend keeps growing

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In May, Algonquin raised its dividend by 10 per cent – its second increase in less than a year. Dividend hikes are a strong signal of confidence, and the fact that Algonquin raised its payment three months earlier than analysts had expected suggests the company is eager to put its recent troubles behind it. The stock now yields an attractive 5 per cent – after converting Algonquin's U.S. dividend to Canadian dollars – but the payout ratio remains conservative at less than 65 per cent of estimated 2015 free cash flow. Algonquin's goal is to increase its dividend by 10 per cent annually over the long run, backed by growing earnings and cash flow from its power generation, utility and transmission assets.

Insiders are buying

Algonquin's chief executive officer Ian Robertson recently purchased 7,500 shares at $9.11 in the open market. That followed purchases by other insiders including Algonquin's chief financial officer and an independent director.

"In our view, the CEO's share purchase should provide the market with another show of confidence by management and could also be viewed as a positive sign that we have moved beyond the fourth-quarter delay and internal review," Desjardins capital markets analyst Bill Cabel said in a June 9 note. Mr. Cabel added that Algonquin "remains one of the best names in the sector" and said the recent share price weakness "has created a good entry point for investors with a longer-term view who appreciate AQN's strong dividend growth outlook."

Analysts are still positive

Analysts are still bullish on the company. Of the 10 Canadian firms that cover the stock, eight rate it a "buy," with one "hold" and one "sell." The lone bear is Accountability Research, whose analyst issued a report on June 16 criticizing Algonquin for its "lack of transparency, high debt load and higher than average execution risk as a result of both recent and announced acquisitions and the continued need to grow." Accountability Research's $7 target price is well below the average of $11.17 for the other nine analysts, according to Bloomberg.

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Earnings are relatively low risk

Algonquin owns utilities that distribute electricity, natural gas or water to about 500,000 customers in 10 U.S. states. On the power side, it has a direct or indirect interest in dozens of wind, solar, hydro and thermal generating facilities in Canada and the United States. The regulated nature of the utilities and the long-term contracts backing the power business provide for stable and predictable cash flows. And those cash flows are growing steadily as the company develops new renewable power projects, invests in its regulated distribution and transmission businesses and makes acquisitions.

It delivers income – and growth

With Algonquin, you get the best of both worlds – income and growth. "We believe the current growth pipeline, coupled with the company's track record of making accretive acquisitions, supports the expected 10-per-cent annual dividend growth through the next several years," RBC Dominion Securities analyst Nelson Ng said in a note following the release of first-quarter results in May.

Closing thoughts

No company is without risks. If bond yields were to rise sharply, for example, Algonquin and other interest-sensitive stocks could take a hit. Mr. Ng's "downside scenario" is $8 a share, but that assumes a rise of two to three percentage points in long-term interest rates, which seems unlikely. His "base case" target of $11 is derived by applying a multiple of 12.5 to his estimated 2016 forecast for EBITDA (earnings before interest, taxes, depreciation and amortization) – "a slight premium to the peer group due to Algonquin's attractive growth profile," he said. Remember to do your own due diligence before investing in any security.

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About the Author
Investment Reporter and Columnist

John Heinzl has been writing about business and investing since 1990. A native of Hamilton, he earned a master's degree from the University of Western Ontario's Graduate School of Journalism and completed the Canadian Securities Course with honours. More

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