Another Look at the Algonquin Power Income Fund

Tom Konrad, Ph.D., CFA

The Algonquin Power Income Fund (AGQNF.PK) has been one of my star performers in an excellent year.  Is it still a good investment at these prices?

 Since I recommended the Algonquin Power Income Fund (AGQNF.PK/APF-UN.TO) in January as a renewable energy income stock for 2009, the company is up 69%, in addition to the C$0.02 monthly dividend, worth approximately another 8% through August on the US$1.82 purchase price, making it the second-best performing of my ten picks (after Cree, Inc (CREE).)  However, since the major basis for my recommendation at the time was the stock’s extremely cheap valuation and high yield, I thought it was worth revisiting, on the occasion of the company’s Q2 update [pdf]. 

Major events in the first half  were Algonquin’s planned acquisition of a 50% stake in California Pacific Electric Company (Calpeco), the former California assets of NV Energy (NVE), and the fund’s plan to convert into a corporation and acquire some tax loss assets through a deal with Hydrogenics Corporation (HYGS).

Calpeco

The Calpeco deal gives Algonquin some exposure to electricity transmission and distribution (in which their partner Elmira has management expertise) in addition to their current exposure to renewable energy generation.  Since I like the potential opportunities in electricity transmission, I think this was a step in a good direction for Algonquin.  Furthermore, about half of Algonquin’s stake in Calpeco will be financed with an equity investment in Algonquin from Elmira at C$3.25 per unit.  Since this is only slightly below the current price, and well above the price at which I recommended the stock, the transaction will be non-dilutive for both me and my readers, and a reasonable exchange for more recent investors.

Hydrogenics

In July, a reader worried that the deal with Hydrogenics was a bad idea because Hydrogenics is a fuel cell company, an alternative energy sector neither of us is enthusiastic about.  In fact, this is a short term deal, and shareholders need not be concerned with ending up owning a fuel cell company when they thought they owned a renewable energy power producer.  Despite the legal complexity, this deal is not a tie-up with Hydrogenics, but rather a way for Algonquin to acquire corporate status, and Hydrogenics’ tax loss assets at the same time.  Because Algonquin is profitable, and Hydrogenics is not, these tax loss assets are valuable to Algonquin, but not Hydrogenics, allowing both companies to benefit. Algonquin will gain the benefit of Hydrogenics previous losses in exchange for a cash payment, which will allow the cash-poor, unprofitable company to continue operations. The transaction has been approved by Algonquin unitholders and Hydrogenics shareholders, and awaits regulatory approvals.

Results

The Trust’s first half revenue was down compared to 2008, which management attributes to lower natural gas prices.  Gas prices affect the trust’s revenues through lower contract prices for the heat from their thermal generation units.  I find this to be a good sign, since I expect that low current natural gas prices will rebound because they do not provide sufficient incentive for natural gas companies to drill and replace the gas supply from depleting wells. Although I expect that low natural gas prices will depress revenues in the short term, Algonquin’s operating cash flow and earnings should continue to be easily sufficient to fund distributions to unit holders with plenty left over to fund Algonquin’s growth plans.

At current prices of C$3.32 for APF-UN.TO and US$3.07 for AGQNF.PK, with a yield of 7.2%, I consider Algonquin to be reasonably valued, and continue to hold my positions.  However, because I currently expect a market decline, I would only suggest buying Algonquin today if you also hedge your position against general market moves.

DISCLOSURE: Tom Konrad and/or his clients have long positions in AGQNF.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.