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Is Algonquin Power Stock a Buy as it Undergoes a Strategic Review?

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Written by Brian Paradza, CFA at The Motley Fool Canada

Renewable energy stock investors may have expected elevated volatility in Algonquin Power and Utilities (TSX:AQN) stock to accompany an earnings release on Thursday. AQN stock was a renewable energy stock to watch during the build-up to the company’s first-quarter 2023 earnings report, and it remains so. Investors recently received news of activist investors potentially “meddling” with the company’s affairs. Subsequently, Algonquin Power announced the commencement of a strategic review process on May 11, 2023. The outcome could significantly impact AQN’s stock price.

Algonquin’s underperforming business under review

Algonquin Power reported 6% year-over-year growth in first-quarter revenue to US$778.6 million, a 15% year-over-year decline in adjusted earnings, and a 4% drop in adjusted funds from operations.

Top-line growth was largely influenced by rate increases and inflation cost pass-throughs in the company’s regulated utility business segment, the Regulated Services Group.

Revenue generation was lower in the Renewable Energy Group segment. This was due, in part, to lower productivity and unfavourable energy market pricing. Renewable energy assets aren’t performing as well as AQN stock investors may like.

The $8.1 billion utility and renewable energy company is struggling with a US$7.3 billion ($9.9 billion) debt load that is accruing higher interest costs in 2023. Operations should ideally grow revenue and cash flow to cover rising cash costs and debt repayments, and help maintain AQN’s dividend, which suffered a 40% cut in January as the company sought to preserve its balance sheet.

Subsequently, Algonquin Power and Utilities announced the commencement of a strategic review process for its renewable energy assets on May 11, 2023. The company formed a committee of three corporate directors who will open-mindedly review go-forward options to unlock trapped value in the company’s underappreciated renewable energy portfolio.

What could AQN do with its renewable group assets?

Since Algonquin Power indicated that it’s taking an open-minded approach in evaluating strategic options for its renewable energy assets, any potential outcomes are possible. Options may include non-core asset sales to reduce debt, lower interest costs, and freeing up cash flow for potential dividend raises.

Alternatively, Algonquin Power may spin off its renewable energy assets into a new, separately managed, listed, pure-play renewable energy entity. A spin-off might attract a new investor base more appreciative of the future of renewable energy. The company may subsequently sell green bonds and long-dated “green debentures” to lower its capital costs.

That said, there aren’t any guarantees that any transactions may happen after the strategic review.

Should you invest in Algonquin Power stock right now?

Algonquin Power stock is a speculative renewable stock to buy as it undergoes a financial strategic review. The outcome of its business review strategy focused on renewable energy assets might be favourable to its leverage and cost of capital, accretive to earnings and free cash flow generation, and make the market fall in love with the stock once again.

A lot has changed over the past few months. Contained inflation rates and stalled interest rate hikes in the United States and Canada have created a favourable planning and financial recalibration macro-economic environment for renewable energy projects that flourish.

Activist investors have a long track record of influencing significant strategic changes in listed companies. Management seems to have listened to activist investor Corvex Management and could have taken some input from a friendly meeting with Starboard Value LP in April. The review is likely to change the business, its financial plans, and asset portfolio, and unlock value for AQN stock investors.

Investors buying AQN stock today may lock in a US$0.108 per share quarterly dividend yielding 5% annually. Dividend investors have a passive income machine, among many others, to keep holding in their portfolios.

Risks to consider

The ongoing review is also a significant risk factor. It may produce no strategic change for the firm. Even if it does, there’s execution risk. Further, there’s potential for a dividend review by management. Not everyone may be comfortable with the process. The ongoing review, which comes a short five months after another, implies a distressed business at a crossroads, a business unsure of its future, and a company that could be on a long-drawn financial downtrend as it struggles with debt and rising interest costs.

The post Is Algonquin Power Stock a Buy as it Undergoes a Strategic Review? appeared first on The Motley Fool Canada.

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Fool contributor Brian Paradza has no positions in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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