If you check out most online quote services, Algonquin Power & Utilities‘ (AQN 1.18%) dividend yield will be listed at over 9%. Don’t count on that continuing though. Management has already announced that the dividend will be cut by 40% in 2023. Given the recent stock price, the going forward yield is more like 5.5%.
Still, that’s pretty generous. But even after a 40% stock price decline over the past year, the risks probably outweigh the rewards when it comes to owning Algonquin Power & Utilities’ stock. Here’s why.
The dividend is unsustainable
The boards of directors of most companies generally don’t like to announce dividend cuts. For starters, investors frown on them, often leading to poor stock price performance, and such changes, rightly or wrongly, are seen as a commentary on a company’s business prospects. So it is highly likely that Algonquin Power & Utilities didn’t make the decision to cut the dividend by 40% lightly.
The numbers are actually pretty telling. Prior to the cut, the dividend was $0.1808 per share per quarter, or $0.7232 per year. The new rate is $0.1085 per share per quarter, or $0.434 per year. When the company announced the pending dividend reduction, it also provided rough guidance for full-year 2023 adjusted earnings of between $0.55 and $0.61 per share.
Put simply, it just couldn’t afford the old dividend. Even the new rate will leave the company with a dividend payout ratio of roughly 80% at the low end of earnings, which is still kind of worrisome.
The cut, however, shouldn’t have been too shocking, because at the end of the third quarter of 2022, management lowered its full-year 2022 earnings guidance to a range of $0.66 to $0.69 per share, down from the previous range of $0.72 to $0.77. The 2022 dividend of $0.7232 per share outstripped the lowered guidance, which hinted that a dividend cut was a very real risk.
Adding to the fire
Another important piece of the story, however, is Algonquin Power & Utilities’ financial strength. Although the Canadian renewable energy and regulated utility conglomerate with assets across North America has an investment-grade-rated balance sheet, credit rating agencies tend to be slow to make changes. This is why it pays to look at the actual numbers before making an investment. In this case, the company’s debt levels have been on the rise, with total long-term debt up more than 80% over the past three years.
It should be little surprise, given this trend, that leverage has been increasing. To track that, you can see that Algonquin Power & Utilities’ debt-to-equity ratio has been trending higher.
Earnings per share, meanwhile, have been fairly erratic over that span. Over the past few quarters, they have been falling kind of precipitously.
Put the above points together, and you get a company that is having increasing difficulty covering its interest costs. The times-interest-earned ratio, which is a quick way to track interest-paying ability, is still above 1, which means it is covering its interest costs. But the ratio has fallen sharply of late. That’s not a good sign.
Now add in some additional details from the business update in which management announced the dividend cut, including plans to sell assets to pay down debt and the ongoing pursuit of a material acquisition that may not actually come to fruition. And, of course, the dividend cut was made to “improve financial flexibility” as the company looks to maintain its investment-grade rating.
All of that, plus the lowered guidance, suggests things are likely to get worse before they get better for Algonquin Power & Utilities. This is a pretty bad backdrop for investing in a company.
Most should wait
If you are looking at the fat 9% yield listed at many online quote services for Algonquin Power & Utility, know that it’s not a real number. And even after the announced dividend cut, there’s good reason to worry about the sustainability of the payout. Until this high-yield stock can stabilize its business, most investors, and particularly conservative income types, should probably watch from the sidelines.