Algonquin: Likely To Sell Atlantica (OTCMKTS:AGQPF)

Current FERC Resolution

The newest hassle for embattled utility, Algonquin Energy & Utilities Corp. (NYSE:AQN) comes from a latest resolution from the Federal Power Regulatory Fee (FERC) denying Algonquin’s proposed acquisition of Kentucky Energy from American Electrical Energy Firm, Inc. (AEP). FERC cited the opinion that the “candidates have failed to indicate that the Proposed Transaction is not going to have an opposed impact on charges” as the premise for his or her resolution.

Shares of Algonquin quickly spiked on December 16, 2022 on the information of the FERC resolution, as buyers noticed a possible off ramp for the transaction. Whereas the ~5% tick up in AQN’s share worth implied that the market wish to see the deal die, I believe it’s nonetheless extra possible that deal is delayed somewhat than cancelled.

The FERC resolution does give Algonquin some choices, and maybe some respiratory room forward of the April 2023 transaction outdoors cut-off date. Algonquin would nonetheless have to make affordable efforts to finish the transaction. Ought to it not have the ability to shut the transaction, Algonquin could be liable for a $65M break charge. I might view the FERC resolution as a velocity bump somewhat than an off ramp in Algonquin’s plans for Kentucky Energy. It’s prone to reapply and make applicable submission modifications to achieve regulatory approval.

If Algonquin is permitted to stroll away from the deal, it is not going to be a silver bullet for all the corporate’s present challenges. The corporate nonetheless has an enormous capital plan to fund and an unsustainable payout ratio. With these challenges in thoughts, Algonquin is prone to proceed with some important divestments.

Atlantica Sustainable Infrastructure

Between 2017 and 2018, Algonquin acquired its non-controlling possession curiosity in Atlantica Sustainable Infrastructure plc (AY) by way of two massive transactions. Algonquin’s first 25% curiosity was bought from Abengoa, S.A. (OTC:ABGOF) at a worth of $24.25 per share, for a complete buy worth of roughly $608M. This was adopted by a second transaction for a further 16.5% fairness curiosity in Atlantica with a complete buy worth of roughly $345 million, primarily based on a worth of $20.90 per share.

Atlantica Sustainable Infrastructure Plc, previously Atlantica Yield Co, owns a portfolio of diversified renewable belongings all through North America, South America and Europe. This portfolio consists of 41 renewable properties with 2,121 MW of mixture renewable power, nearly all of which is photo voltaic. The corporate additionally owns and operates a set of pure gasoline energy services, water desalination initiatives and a 1,229 miles of electrical transmission traces.

Algonquin’s 44.2% possession stake in Atlantica gives the corporate publicity to nice renewable belongings with long-term contracted income. Atlantica’s weighted common remaining contract life is roughly 15 years, offering long-term money stream visibility. Algonquin’s possession stake in Atlantica entitles it to roughly US$81M in dividends yearly, which flows on to Algonquin’s earnings.

Algonquin’s Choices

Algonquin’s important publicity to floating fee debt has resulted in a looming money crunch. As famous in my earlier evaluation of Algonquin, the corporate’s floating fee debt will balloon from $1.7B at present to over $3B if the Kentucky Energy deal closes. Algonquin is exploring all accessible choices to boost the money wanted to shut the pending transactions and take up this extra debt. Algonquin has traditionally been profitable in elevating fairness capital on the market to fund its capital plan. Whereas this has had a dilutive impact on shares, the technique has been efficient for the corporate funding previously. With investor confidence in tatters and the share worth halved during the last 12 months, it’s unlikely that Algonquin will elevate any extra fairness within the close to future. Administration has continued to reiterate the significance of sustaining an funding grade credit standing; subsequently, it is usually unlikely that the corporate will look to problem extra debt.

This leaves asset gross sales, shrinking the capital plan and decreasing the dividend because the most probably sources of capital. I preserve the view that the dividend will likely be reduce whatever the FERC resolution and the result of the Kentucky Energy deal. The market has already priced in a reduce and buyers expect it. With a present yield of 10.5%, the agency might reduce the dividend by 50% and nonetheless present enticing dividend earnings relative to different utilities.

Assuming a 50% dividend reduce, the corporate would unlock roughly $260M yearly. Whereas that is substantial, it doesn’t present all the corporate’s money wants or tackle funding for the capital plan. Earlier than Algonquin bumped into hassle with rising rates of interest, asset recycling was already slated to be a core a part of the corporate’s capital plan funding mannequin. The timeline for asset gross sales will possible must be accelerated and the divestments extra important than beforehand thought-about.

Will Algonquin Promote Atlantica?

The most probably asset for the corporate to divest, is Algonquin’s stake in Atlantica. The mixture of the Atlantica divestment and a 50% reduce to the dividend would unlock nearly $1.5B within the first 12 months. This might allow Algonquin to finish the Kentucky Energy transaction and repair the extra $400M in variable fee debt that the corporate would assume with the transaction. Based on RBC Dominion Securities Analyst Nelson Ng:

If AQN acquires KP, we imagine AQN would want to chop the dividend, speed up asset gross sales, and shrink its capital plan to bolster its steadiness sheet. We imagine the plain asset to divest could be its ~$1.3 billion stake in Atlantica Sustainable Infrastructure (though this has not been particularly mentioned by the corporate it’s a comparatively passive funding in a publicly listed firm with restricted strategic worth, in our view), which might fund a lot of the ~$1.4 billion KP fairness buy worth.

As Trapping Worth identified of their latest article “Algonquin And Atlantica Sustainable: Paying The Piper”, Atlantica is much less levered than Algonquin as a complete, with Debt/EBITDA of seven.3X vs Algonquin’s 12.9X, so promoting this asset will not assist the corporate’s operational threat profile. It might additionally see the corporate forgo its stream of dividend earnings from Atlantica, value roughly $0.12 per share of AQN.

Promoting Atlantica Relative to different Property

Algonquin had $17B in belongings as of Q3 2022, giving it optionality on how greatest to pursue capital recycling. If a big asset sale is required to restore the steadiness sheet and full the Kentucky Energy deal, these belongings are prone to disproportionally come from the renewable facet, somewhat than the regulated facet of the enterprise.

Atlantica is a set of 41 renewable era belongings and a few transmission belongings in Europe and the Americas. These are nice properties, nonetheless they’re peripheral to Algonquin’s core regulated enterprise and should not built-in into Alqonquin’s (Liberty) operations. Briefly, whereas it is a good to have, the corporate’s Atlantica possession is just not a crown jewel.

Algonquin’s regulated enterprise is 7X bigger than its renewable division by income. Since 2019, revenues from the renewable enterprise have grown by 4.4%, whereas income from the regulated enterprise has elevated 42% over the identical interval.

Supply: Algonquin

This development sample highlights that Algonquin’s precedence is to proceed its centered development technique in its regulated enterprise. By promoting Atlantica somewhat than a regulated asset, Alqonquin can preserve the broad course of strategic development it has pursued lately, somewhat than spook buyers additional by doing a strategic about-face.

This development of focusing on renewable belongings for disposition has been highlighted within the agency’s latest capital recycling actions. In October, 2022 Algonquin introduced the outcomes of its inaugural asset recycling transaction that included the sale of a 49% possession curiosity in three working wind services in the USA totaling 551 MW and an 80% possession curiosity in a 175 MW working wind facility in Canada. The whole money proceeds from these inclinations had been roughly $277M for the U.S. wind farms and roughly C$107 million for the Blue Hill Wind Facility. These divestments had been a comply with by way of on the corporate’s 2021 Investor Day dedication to make the most of asset recycling to fund and execute Algonquin’s $12.4B capital plan.

Current Purchaser Curiosity for Atlantica

In November 2022, Searching for Alpha reported that shares of Atlantica traded larger “following a report that the renewable power firm could have acquired a takeover bid”. This information launch goes on to say that the Atlantica could also be evaluating conducting a strategic evaluate after receiving curiosity from an unidentified social gathering. Ought to Atlantica be a takeover candidate, Algonquin might doubtlessly see a premium over the present market worth for his or her possession of AY. This might make the choice to divest Atlantica extra enticing relative to different belongings in the meanwhile.

Algonquin’s stake in Atlantica is straightforward to worth as Atlantica is a publicly traded firm. Because the Atlantica renewable belongings are geographically distributed and have enticing long-term energy buy agreements in place, it may very well be a bolt-on acquisition for a broad array of companies or asset managers seeking to diversify or add scale to an current power portfolio.

January twelfth Investor Replace

Following the final incomes launch on November 11, 2022 the place AQN reduce its 2022 EPS steerage, shares of AQN have dropped nearly 40%. Administration has made some minor makes an attempt to quell uncertainty by releasing a letter on November 17,2022 highlighting some insider shopping for and a dedication to offering buyers with extra updates at an Investor Day in early 2023. On January 12 at 8:00am ET Algonquin Energy & Utilities President and CEO Arun Banskota and CFO Darren Myers will host an investor name to offer a enterprise replace. You possibly can be part of the webcast of the decision right here.

I imagine many buyers together with myself are in a holding sample awaiting a coherent plan on January 12, 2023 that may converse to:

• the pending $2.6B Kentucky Energy acquisition and the way the latest FERC resolution impacts administration’s dedication to the transaction,
• commentary about potential asset gross sales and accelerated capital recycling, particularly for AY
• a sign concerning the degree of dividend to be paid going ahead
• to what extent the steadiness sheet will likely be prioritized with respect to sustaining an funding grade credit standing

With the enterprise replace being provided in lieu of an investor day, we could have to attend for extra particulars concerning the firm’s capital plan and revised 5-year development plan.

Lowered Valuation

One of many possible outcomes from the following part of Algonquin’s reorganization is to alter its enterprise combine to have a higher give attention to its regulated utilities enterprise on the expense of its renewable enterprise. If the enterprise combine strikes additional in direction of the regulated facet, the corporate might even see a decrease valuation a number of going ahead.

The estimated 2022 EV/EBITDA and P/E for a basket of regulated Canadian utilities [Algonquin, Canadian Utilities Limited (CU:CA), Emera Incorporated (EMA:CA), Fortis Inc. (FTS) and Hydro One Limited (H:CA): averaging 93% regulated revenue] was 11.8X and 18.2X respectively. This compares to estimated 2022 EV/EBITDA and P/E of 16.4X and 23.5X respectively for a basket of diversified utilities [Black Hills Corp (BKH), CenterPoint Energy, Inc. (CNP), Chesapeake Utilities Corp. (CPK), Dominion Energy, Inc (D), NextEra Energy, Inc. (NEE), Public Service Enterprise Group (PEG) and Sempra (SRE): averaging 72% regulated revenue] with the same mixture of regulated and non-regulated income (roughly 70/30%). Whereas this evolution might even see decreased volatility going ahead, it might additionally see Algonquin ascribed a decrease a number of over the long-term.

What’s Subsequent for Algonquin?

I anticipate the corporate will possible want to scale back its capital program, divest belongings and cut back its dividend. Divesting Algonquin’s 44.2% stake in Atlantica is essentially the most expedient and concrete motion the corporate can take to persuade the markets that pursuing the Kentucky Energy deal gained’t destroy any extra shareholder worth. Even when the Kentucky Energy deal is accomplished, a much less formidable capital plan and a higher give attention to regulated earnings might end in a decrease valuation for Algonquin going ahead.

Editor’s Be aware: This text discusses a number of securities that don’t commerce on a significant U.S. alternate. Please concentrate on the dangers related to these shares.