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Written by Vineet Kulkarni at The Motley Fool Canada
Algonquin power (TSX:AQN) Stocks continued to slide last week, even after the chief executive tried to calm the storm. It has fallen more than 35% since November 11 and is currently trading at its lowest level in seven years.
Some so-called market pundits recommend that the stock earn a hefty dividend yield. Some excitement is warranted as Algonquin has been a major wealth creator among utilities in the past. However, this time investors need to see the red flags and act accordingly.
Should I buy AQN shares?
Algonquin reported a 27% decline in earnings for the third quarter of 2022 year-over-year. Such a drop is rare among utilities with large regulated operations. Thus, investors’ anger was evident and the title was punished in the following weeks.
Along with lower earnings, management’s sketchy forecast also hurt investor sentiment. It lowered its earnings forecast to $0.66 to $0.69 per share for 2022. Moreover, the challenges that have weighed on its earnings recently are likely to persist next year as well.
Rampant inflation and rapid rate hikes dramatically increased Algonquin’s interest costs and dented its profits. A large portion of its debt is exposed to variable interest rates. Therefore, as interest rates rise, Algonquin will most likely spend more on debt servicing, which will have an even greater impact on its bottom line.
More worryingly, Algonquin is buying Kentucky Power for $2.6 billion. This should further inflate its debt, making earnings management more difficult.
Rising debt and weakening outlook
After the recent drop, AQN stock is trading at an industry-best 7% dividend yield. However, note that this is because of the fall in stocks and not because of the increase in the dividend.
There is, in fact, a significant risk of a dividend cut, given the comments and indications. For 2022, Algonquin will likely earn $0.68 per share based on the midpoint forecast. However, it will pay a dividend of $0.71 per share this year, implying a payout ratio of 104%. A payout ratio above 100% means he has to borrow money to pay dividends or dilute shareholder holdings. Simply, the scenario is not achievable in the long term.
Algonquin has also consistently engaged in stock dilution in the past. At the end of 2019, AQN had 504.7 million shares outstanding. However, the number increased to 683.4 million at the end of November 9, 2022. In fact, the company sold nearly 4.8 million shares between September 30 and November 9, 2022, taking into account the post-earnings impact on the stock.
As the number of shares outstanding increases, the holdings of existing shareholders lose value. Algonquin will likely dilute further, as it appears to be a cheaper option at the moment, making stock recovery less likely.
Algonquin was more popular with investors a few years ago. It has invested aggressively in renewable energy projects and has shown above-average growth over the past decade. Over the period 2010-2020, AQN stock has returned 22% compounded annually, far more than its peers. However, as supply chain issues have rattled the renewable energy sector and amid interest rate increases, the tables have quickly turned, affecting its operational and financial growth.
At the end of the line
While AQN may continue to trade weak, investors will get more clarity on its next outlook early next year. High leverage in a rapidly rising rate environment makes AQN stocks a risky bet right now. So it looks like investors would be better off with other more stable, long-term dividend-paying TSX stocks.
The post Why I’m Not Falling In Love With Algonquin Power’s 7% Dividend Yield appeared first on The Motley Fool Canada.
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The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy. Foolish contributor Vineet Kulkarni has no position on the stocks mentioned.
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