Algonquin Power faces an uphill struggle to win back investor confidence

Algonquin Power & Utilities Corp. AQN-T used to be a sweetheart stock: a solid utility with a lovely dividend. Then it took a hit and ever since has been going down like a torpedoed ship. I have hung on from the peak. Do you think it will return or is it time to cut it loose?

In case you missed my column at the time, I turfed Algonquin from my model Yield Hog Dividend Growth Portfolio in November, 2022, a few months before the company slashed its dividend by 40 per cent. I later sold all my personal shares because I was concerned that the company, which was struggling with rising costs for its variable-rate debt, would cut its dividend again, which it did this past August, by another 40 per cent.

The stock price, not surprisingly, has collapsed. The shares were trading Friday morning at about $6.25 on the Toronto Stock Exchange, down 72 per cent from their record high of $22.67 back in February, 2021. I don’t need to remind you that the trend has not been your friend here.

But that’s all in the past. What about the future?

Well, Bay Street clearly doesn’t have much love for the stock. Of the 11 analysts who follow the company, there are 10 hold recommendations and just one buy, according to Refinitiv. The average price target is US$5.50, or about $7.90. But take that with a lump of salt, as analysts’ targets are often overly optimistic.

The reality is that nobody knows where Algonquin’s share price is heading, but the odds of a quick rebound seem remote.

“We remain cautious on the name,” Mark Jarvi, an analyst with CIBC Capital Markets, said in a note after Algonquin released its third-quarter earnings in November.

“AQN’s share price is trying to find a bottom, but the downward slide may not end until the market figures out where earnings will trough in 2025 and investors gain more clarity/confidence on a path forward on better utility earnings,” said Mr. Jarvi, who has a “neutral” rating on the shares.

In a bid to win back investor confidence, Algonquin is attempting to simplify its structure and transform itself into a pure-play regulated utility. In August, the company announced a deal to sell its renewable energy business, excluding hydro assets, to U.S.-based LS Power for up to US$2.5-billion. Algonquin also recently completed the sale of its 42.2-per-cent equity interest in Atlantica Sustainable Infrastructure PLC, with proceeds of both transactions used to reduce debt and recapitalize the company’s balance sheet.

With the renewable assets and Atlantica off the books, Algonquin’s earnings will take a hit next year. Mr. Jarvi estimates that earnings per share in 2025 will fall to about 25 US cents, down from an estimated 33 US cents in 2024 and 53 US cents in 2023. (Reflecting its extensive U.S. utility operations, Oakville, Ont.-based Algonquin reports earnings and declares dividends in U.S. dollars.)

Dividend investors should take note: Mr. Jarvi’s 2025 earnings estimate implies a payout ratio of slightly more than 100 per cent based on Algonquin’s annualized dividend of 26 US cents a share, which yields about 6 per cent. While the dividend doesn’t appear to be in any immediate jeopardy, Algonquin will need to grow its earnings over the next few years to bring its payout ratio down to a more manageable level.

One potential bright spot is that Algonquin currently has roughly a dozen rate cases before various public utility commissions. As a regulated water, gas and electric utility, Algonquin must apply to raise the rates it charges customers, which allows it to earn a return on the capital it invests in its utility infrastructure. But the rate-setting process, which requires input from utility customers and other stakeholders, can take a year or more, which means any earnings boosts from rate cases will not show up in Algonquin’s earnings immediately.

Mr. Jarvi expects that Algonquin’s earnings will “improve over time” but says it will likely be 2027 or 2028 before earnings per share get close to 40 US cents, which would bring the payout ratio down to 65 per cent – the midpoint of management’s target range.

Other analysts are also taking a wait-and-see approach to the stock.

“We continue to believe 2025 will be a tough year as the company transitions to being a pure-play utility,” Brent Stadler, an analyst with Desjardins Capital Markets, said in a note to clients. “We believe there are a lot of moving parts in the numbers and continue to look for clarity and execution.”

Mr. Stadler rates Algonquin a hold, with “above-average” risk.

You’ll need to decide whether you have the patience, and the confidence, to stick with Algonquin while it works through its challenges. If not, there are plenty of other stocks with similar yields, but without the same degree of uncertainty.

I recently read of someone recommending a strategy where you take money out of your tax-free savings account near the end of the year and add it back in the new year. It supposedly increases your contribution room. I cannot understand this idea. If you simply left the money in the TFSA and invested it, wouldn’t you get the same result?

You are correct. When you withdraw money from your TFSA, the amount is added to your contribution room as of Jan. 1 of the following year. For example, assuming you’ve maxed out your TFSA contributions every year, if you withdraw $5,000 from your TFSA on Dec. 30, you will be able to contribute $5,000 as of Jan. 1, plus $7,000 of new contribution room that every eligible TFSA holder receives for 2025, for a total of $12,000.

But have you gained anything by withdrawing $5,000 and putting it back a few days later?

No. However, there are circumstances in which making a TFSA withdrawal, and later recontributing the money, could make sense. For example, imagine you have a large expense such as a kitchen renovation. You could withdraw, say, $20,000 from your TFSA in July to pay for your reno. Then you could start saving funds to replenish your TFSA the following year when that additional $20,000 of contribution room becomes available.

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.