Algonquin Power & Utilities Corp.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

Algonquin Power & Utilities Corp. is a diversified generation, transmission and distribution utility, primarily focused on renewable energy and regulated services across North America.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview Algonquin Power & Utilities Corp. (AQN) operates two primary business segments: Regulated Services and Renewable Energy.

  • Regulated Services: This segment includes regulated utilities that distribute electricity, natural gas, and water. The majority of revenue is derived from regulated utility operations in the United States. They provide these services to residential, commercial, and industrial customers.
  • Renewable Energy: This segment consists of renewable energy generation facilities, such as wind, solar, hydro, and thermal power. These assets generate electricity, which is then sold through long-term power purchase agreements, primarily to other utilities.

It is important to note that AQN has a strategic initiative to reduce its business risk by focusing on its core regulated utilities business while decreasing its exposure to renewable projects. They have sold some of the renewable power plants in 2022 and 2023 and are continuing to pursue this strategy.

Revenue Distribution

AQN’s revenue is primarily derived from its regulated utility business, which provides a more predictable cash flow stream due to their regulated nature. The renewable generation business, while a critical component, contributes a more volatile income stream as it is dependent on long-term contracts that provide power at a fixed rate over a time period.

  • Regulated Utilities: The most important stream that provides predictable recurring cashflows. Approximately 70-75% of the company’s revenue comes from regulated utilities.
  • Renewable Energy Generation: About 25-30% of the company’s revenues are from their renewables segment.

Trends in the Industry

  • Increased Focus on Renewable Energy: The industry as a whole is shifting towards renewable energy, with increasing demand for clean energy sources and government-backed incentives. However, there is increased scrutiny on renewable companies to perform better and earn consistent returns from these ventures.
  • Infrastructure Investments: There is a strong focus on grid modernization and infrastructure upgrades to support the increasing demand for power and integration of renewables.
  • Regulatory Scrutiny: The regulated utilities industry is subject to increased oversight, particularly in terms of the price that regulated monopolies can charge, safety regulations, and environmental concerns.
  • Rising Interest Rates: The rise in interest rates means increased costs on debt and lower valuations on the value of the infrastructure.
  • Capital Intensity: Utilities businesses are very capital intensive.
  • Focus on Energy Security and Transition: The war in Ukraine has also brought about more interest in investing in energy security and transition. Companies are looking for ways to become more stable and less reliant on other foreign nations for their energy needs.

Margins

Operating margins in regulated utilities tend to be relatively stable and predictable due to their rate-based nature. However, they face scrutiny from regulators, who don’t want these monopolies to generate excessive profits. The renewable business can have higher margins, due to the lower cost of electricity from renewables, however, the long-term fixed rate contracts they have signed can put pressure on profitability.

As they are divesting from the Renewables segment, their reliance on high-margin renewables revenue sources has reduced, impacting margins.

Competitive Landscape The regulated utilities sector is often dominated by large, established companies that have geographic monopolies or strong local franchises. Competition can be low in the sense that no one else is present and can’t really enter the region, however they compete with alternative forms of energy and are carefully watched by regulators. The renewable energy generation space is much more competitive and fragmented with many regional and global players, and is characterized by new entrants, consolidations, and different technology approaches.

What Makes AQN Different

AQN combines regulated utility services with a significant stake in renewable energy generation. This diversification strategy allows it to benefit from the long-term trend towards clean energy while generating predictable cash flows. Furthermore, the company has a significant presence and scale across several states and provinces in the USA and Canada.

Moat Assessment: 2/5

AQN possesses a Narrow Moat, which is justified through the company’s:

  1. Regulated Monopolies: The regulated utility segment benefits from geographic monopolies, which create barriers to entry and provide a relatively stable revenue stream. However, these are subject to regulatory scrutiny and rate caps. These are the core areas of AQN.
  2. Long-Term Contracts in Renewables: Long term contracts in the renewable energy segment provide some stability in revenue. However, the increasing level of competition and decreasing costs of production could impact these profits.
  3. Established Scale & Regional Presence: AQN has scale and a strong presence across different markets in USA and Canada, providing them with an advantage over some smaller players and some ability to cross-sell and cross-subsidize businesses. However, this is not a huge differentiation, as there are many established players in each market.

Despite these factors, the moat is fragile due to:

  • Capital intensity
  • Regulatory risks
  • Exposure to competition, especially in the renewables segment
  • Need for consistent performance on profitability
  • Limited pricing power
  • Exposure to interest rate fluctuations

Legitimate Risks That Could Harm the Moat

  • Regulatory Actions: Changes in government regulations or unexpected decisions from regulators could result in lower profitability for their regulated assets. In general, regulatory environments make it harder to price assets at an advantageous rate.
  • Competition in Renewables: The renewable energy generation sector is becoming increasingly competitive, making it harder for AQN to maintain its existing contracts, profit margins, and win new contracts.
  • Technological Disruption: New technologies in energy generation, distribution, or storage could render AQN’s investments in existing infrastructure obsolete. For example, future development in battery technology can severely disrupt the business.
  • Financial Risks: AQN’s large amount of debt can expose them to the risks associated with increasing interest rates, potentially hurting profitability. They have already seen their shares tumble down in the past few years when interest rates increased, and they had to reduce the dividend payouts to their shareholders.
  • Customer concentration If they are overly reliant on a single client, a loss of that client will negatively impact the financial health of the business.
  • Macroeconomic disruptions: Events such as financial crisis, inflation, etc can negatively impact their business.
  • Climate change: More and more severe weather can disrupt the operations of their facilities and incur additional costs.
  • Poor Capital Allocation: Making poor investments into low ROI projects can hamper their overall ability to generate free cash flows and lower the ability of the business to make new acquisitions or expand.

Business Resilience

  • Regulated Revenue Base: The regulated utility segment is generally resilient to economic downturns, as people will always require services such as water, electricity, and gas. This is the most stable part of their portfolio.

  • Focus on Renewables: Their push into renewables allows them to potentially benefit from future opportunities, such as additional incentives and increasing demand for power, while also trying to reduce their carbon output.

  • Geographical diversification: Having a presence across the USA and Canada allows them to be less vulnerable to disruptions in any single region. However, they don’t have significant operations in areas outside North America.

Financials In-Depth

  • Revenue Growth: AQN has increased its revenues over time, but they have been lumpy with certain periods having high revenue increases, while other periods have had slow or even negative growth. This is due to their heavy reliance on the acquisitions model. In the long term they project stable growth due to the regulated nature of their businesses.
  • The company expects average earnings per share to be within range of $.70 to $.75, an average of 18% per year through 2027. This is on a reduced share count as they have plans to do share buybacks.

  • Long-term growth rates from 4-6% driven primarily by the regulated segment.

  • Profitability: Gross profit margins have remained relatively consistent, with slight fluctuations year to year. However, net profit margins are very volatile due to various write-offs and other accounting irregularities.

  • Operating profit for 2023 stood at $1.665 billion compared to 1.588 billion for 2022.
  • Adjusted EBITDA was $2,223 million in 2023 compared to $2,086 million in 2022.

  • They missed revenue expectations in Q4 2023 due to low renewable energy production from wind farms, even though they have long term contracts for this. This also lowered the revenue by $107 million.

  • Cash Flow: Operating cash flows have shown a steady increase throughout the past years and are usually quite consistent, and that has been the major reason of their stable investment plans. In their earnings calls they have mentioned that the debt to EBITDA has seen some progress and the company hopes to improve it to less than 5.5 by 2026.

  • Debt: Long-term debt is high as the nature of utilities companies are very capital intensive. The company has consistently relied on debt financing.

  • Debt is also mainly denominated in USD so they are highly susceptible to fluctuations in USD currency rates.

  • Equity: The company’s book value has shown a steady increase over the years, but has been volatile.

  • 2022 book value stood at around $7 billion.

  • Share Count: Shares outstanding has also been on an upward trajectory, which highlights the company’s strategy to fund its growth through both debt and equity offerings, as needed. They will reduce their share count through planned buybacks of $100 million a quarter.

  • Capital Expenditures: The company’s capital expenditures are projected to be more than $7 billion over the next 5 years to fulfill their business expansion plans.

Understandability Rating: 3/5 The business model is relatively easy to understand, combining regulated utilities and renewable energy generation. However, the complex financial structure, multiple geographical locations, the volatile renewable business, and exposure to accounting irregularities makes understanding AQN more difficult than your average business. Therefore, we assigned it a rating of 3.

Balance Sheet Health: 2/5

AQN has a high debt load that has been a concern for some time. Many of the assets they have on their books have been acquired through acquisitions and could have some negative surprises from these acquisitions. Their recent financial difficulties related to accounting irregularities have made their overall financial health hard to judge. In conclusion, we give the balance sheet a rating of 2/5.

Recent Concerns and Issues:

  1. Accounting Irregularities: In 2023, AQN had to delay the release of their earnings due to accounting irregularities. There are ongoing investigations into the matter. This has caused significant volatility and uncertainty around the business, affecting its valuation severely.
  2. High Debt: The high level of debt could make the company sensitive to interest rate increases, which might affect profitability and even their credit rating.
  3. Reduced Dividend Payouts: The company has significantly lowered their dividends, which is an indication of reduced profitability of its business and the increased strain they are under due to financial pressures.
  4. Divestitures: The company is going to focus more on the regulated business and is selling off assets in the renewable segment. This indicates a big change in strategy to improve financial health and reduce risk, but it also reduces the high-margin parts of its business.
  5. Underperformance: While the business is stable, the company has struggled to make the business grow and generate high levels of income that would lead to sustained growth and value creation. For this reason, it is not looked at favorably by Wall Street analysts.

Conclusion

AQN is in the midst of a strategic change, and has been under immense pressure due to their accounting irregularities and their high debt levels. While the company has potential due to their regulated utility business, their exposure to renewable energy could make it less sustainable. The coming few years will be crucial to determine whether they will be able to make this transition effectively and increase value for its shareholders.