Algonquin Power & Utilities: ‘I Can’t Quit You, Baby, So I Had To Put You Down For A While’ (NYSE:AQN)
The year was 2006. One of my favorite Canadian stocks, the largest North American peat moss harvester, had just collapsed in the wake of the Halloween Massacre of Canadian Unit Trusts. I was talking to my broker, who is Canadian by birth, discussing the fallout. He mentioned a renewable power producer, Algonquin Power Income Fund, as a potential. It seems his dad is friends with the CEO and indicated the company should be a survivor and should do well over time. Algonquin Power Income Fund was formed in 1997 and began accumulating renewable power assets, such as its initial purchase of hydro-power facilities in Ontario, Quebec, New York and New Hampshire. I kept it on my radar until Oct 2009 when it converted from a Unit Trust to a corporation and made my initial purchase at $3.34 per share.
Since then, Algonquin Power & Utilities (AQN) has been an interesting consolidator of smaller private and publicly-owned utilities. Its first big push as a corporation was to partner with Emera (OTCPK:EMRAF), another Canadian electric utility, and purchase the FERC-regulated high-voltage transmission network around the Lake Tahoe Basin. Emera played banker for the next eight years, buying new equity issues of AQN, and financing its US expansion. Emera maintained its growing ownership of AQN until EMRAF management decided to acquire Florida utility TECO and sold out of its 64 million share position. At its peak, Emera owned 23% of AQN outstanding shares
Since 2009 and using the Liberty Utilities banner, AQN has completed the acquisition of multiple water, electric, and natural gas assets. Algonquin services over 960,000 utility customers with over $10 billion in total assets, $6.9 billion of which are regulated rate base assets. An example is their Nov 2019 announcement of the acquisition of one of largest single-state water utilities, New York American Water NYAW with 125,000 customers mainly on the south shore of Long Island.
Over the years, Algonquin has accumulated utility assets across the country. AQN’s current regulated business spans 14 states. In reviewing the regulatory environment of these states, according to S&P Credit, 4 states are rated Above Average in their support of local utilities, 8 states are rated as Average support, and 2 states as Below Average support. Customer count by utility type breaks down as 29% electric, 32% water (after the NYAW acquisition), and 42% natural gas. While seemingly disjointed, AQN’s management has made it work to the benefit of shareholders. 65% of their business is from regulated activities and 35% from non-regulated renewable power projects, mainly utilizing long-term purchase contracts. Below is a map outlining states served, from their latest investor presentation dated Dec 2019.
Including its 44% interest in Atlantica Yield (AY), management boasts 2.0 GW of wind and solar capacity (of which 600 MW is attributed to AY). Management currently has more green power on the way with 1400 MW of non-regulated generating assets in development and under construction, valued at $2.5 billion. Algonquin has a history of acquiring and constructing renewable power assets utilizing long-term purchase power agreements, PPA, with creditworthy counter-parties. Management currently operates 53 renewable energy facilities, with 86% of revenue from PPA contracts and an average remaining contract of 15 years.
AQN has budgeted $6.7 billion in regulated utility projects and total 5-yr capital expenditures are expected to be $9.5 billion. Similar to other utilities, this capital expenditure budget will drive regulated earnings higher by an anticipated 7% annually, slightly above the sector average. Management has earned a B+ rating from CFRA for its SPGMI Quality Rating, or Average, for 10 yrs consistency in dividend and earnings growth.
Algonquin is a Canadian company with the majority of its assets in the US. The stock has a dual listing on the NYSE and the Toronto Exchange using the symbol AQN.TO. This duel listing makes it a bit easier for US investors to buy shares of AQN. Management decided years ago to pay US investors dividends in US Dollars. This could be a substantial advantage for some who do not desire the exposure and risks/benefits of Canadian/US currently exchange rates as it relates to their quarterly income.
In addition, Algonquin has issued $25 par value “baby bonds” which trade on the NYSE:
• 6.875% Fix/Float Sub Notes; Issued 2018, Due 2078 (AQNA); 3-month LIBOR + 3.93% with the first reset in 2023, and then every 5 years thereafter.
• 6.20% Fix/Float Sub Notes; Issued 2019, Due 2079 (AQNB); 3-month LIBOR + 4.01%, with first reset in 2024, and every 5-yrs thereafter.
I have written about the perils of LIBOR pegged variable rate debt instruments from both a lender and investor vantage point. Not all LIBOR replacement language protects the interested parties in a similar fashion as the original debt instrument. With the pending discontinuation of the now scandal-ridden LIBOR benchmarks, investors should dig a bit deeper into the terms of the specific note for changes when LIBOR is no longer available.
In the case of AQNB, the LIBOR replacement is called out on page S-17 of its prospectus as filed with the SEC. The replacement section calls out for the company to appoint a “calculation agent” to determine an adequate replacement. While it is assumed the “calculation agent” will be a bank, the appointed agent specifically has no fiduciary duties to note holders. While the US Federal Reserve is pushing its SOFR index as a replacement, investors should be leery of their re-calculated interest rate when LIBOR is discontinued in ~18 months, on Dec 21, 2021. Definitely it’s Buyer Beware on all LIBOR-tied floating notes, Algonquin’s included.
I was a strong supporter of Algonquin’s position in the utility consolidation trend and their push into the regulated US market to augment their renewable power generating assets. The connection with Emera provided management with a ready buyer of equity to finance its acquisitions. I felt there were great synergies and advantages if Emera would acquire AQN in its entirety, but Emera management went for a bigger fish in 2016 – TECO in Florida.
Not long after Emera exited the scene, Algonquin management decided to pause its US expansion and to buy into a UK renewable power company, Atlantica Yield (AY). The first tranche of $608 million to purchase 25% of AY was announced in Nov 2017. A year later, in Nov 2018, AQN exercised its option to purchase an additional 16.5% of AY for $345 million. In 2019, AQN acquired an additional 2 million shares for $53 million, for total current ownership of 44%. Total investment into AY is $1.0 billion.
For its $1 billion investment, AQN owns 44% of a company owning international renewable power (76% of 2019 revenues), natural gas power generating (12%), high-voltage transmission network (10%), and water desalinization (2%) facilities. As of Dec 2019, the number of facilities by country, from AY’s latest presentation: Spain – 8; Peru – 6 (transmission); Uruguay – 3; Mexico – 2 (gas); Algeria -2 (water); US – 2; So. Africa – 1.
While structured as a yieldco, similar to other US utility yieldco businesses, and even after considering the annual income of $71 million to AQN from its AY investment, the diversion of capital and management’s attention away from its US expansion in regulated utilities, in favor of these assets, is not to my liking as I believe it alters AQN’s risk/reward profile. I acknowledge the new option for AQN to sell assets to AY, hence monetizing its facilities while retaining a 44% indirect interest.
In addition, the environmental situation in Flint, Michigan concerning their water supply should cause water utility investors to pause just a bit. Starting in 2014, the issues came to a head in 2016. It’s not over yet, with 15,000 of 18,000 feeder pipes having been physically inspected and 9,200 being replaced. According to a 60 Minutes report last month, testing for lead contamination in Flint children could last for years. Imagine the financial downfall if the municipal water company in Flint had been owned by any investor-owned utility. While I remain a 20-year supporter of the trend of water district consolidation and acquisition by investor-owned companies, the underlying risk profile of the industry is becoming increasingly more apparent to the investing public.
I took an initial AQN position in 2009 and added to it in 2015 and 2016. Due to the above reasons, I moved to the sidelines on Algonquin in late 2017. Like the lyrics say, “I can’t quit you baby, so I had to put you down for a while” and I wanted to see how the AY investment turned out. I didn’t sell but rather I let my investment ride, collecting a nicely growing dividend. Then, in Dec 2019, as a defensive strategic move, I placed stop-loss orders for many positions to sell a portion of my holdings. From Dec, I monitored these trigger prices and adjusted them upwards as stock prices rose. AQN was among those, and I trimmed my share count on March 9. Time will tell if this was a timely crossroads to recoup my capital.
Overall, I like management’s return to the US utility acquisition trend with Algonquin’s purchase of NYAW. However, I think the jury is still out considering its AY investment. While I’m not rushing out to replace the shares recently sold, if valuations make a round-trip to their previous virus-induced lows, it could make for a very interesting re-entry point.
“Can’t Quit You, Baby” is a Willie Dixon blues anthem from 1956. The lyrics are classic ‘50’s blues:
I can’t quit you baby,
So, I’m gonna put you down for a while.
The song has been covered by Otis Rush, Led Zeppelin, Rolling Stones, and Joe Bonamassa. The Stones released their version on the “Blue and Lonesome” album in 2016 and is a throwback to their earliest years. The Stones version reminds me of many of their early releases in 1963-1965, as found on their 2017 “On Air” live album compilation. Eric Clapton joins in on the Stones recording, and his solo starts at time stamp 1:51 with Jagger saying, “Yeah, go, Eric”. It’s a tough choice as to which to link, so here is the Otis Rush version and the Stones version. However, for a little heavier sound, the Led Zeppelin and Joe Bonamassa versions are also above outstanding (I’m a little partial to the Bonamassa guitar picking). Enjoy, and don’t forget the volume.
Otis Rush Live: Otis Rush: I Can’t Quit You Baby
Stones I Can’t Quit You, Baby
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Disclosure: I am/we are long AQN, EMRAF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.