Big Question for Algonquin Power & Utilities: Sell or Not to Sell Renewables Biz?

Algonquin Power & Utilities (CA:AQN) reported its first-quarter 2023 results on May 11. And while the Oakville, Ontario company beat the Street, the bigger news was that it would undertake a strategic review of its Renewable Energy Group as part of its overall plan to enhance shareholder value.

While a sale of the Renewable Energy Group could simplify Algonquin’s story with investors, risks are associated with doing so.

Management is under pressure from several activist investors to trim down assets and bolster the balance sheet, So the strategic review might keep them at bay for a brief period.

But, ultimately, to sell or not to sell, that is the question.

Easier to Value

Dividend investors have long been associated with utility stocks because of their regulated revenue streams. In addition to the regulatory protections many utilities receive from state and provincial governments, the demand for power generation generally doesn’t change from one economic cycle to the next, making dividend payments far more reliable over the long haul.

Algonquin CEO Arun Banskota believes the strategic review will find the best course of action for its renewables business.

“Both our Renewable Energy Group and our Regulated Services Group have grown into strong businesses, with scale and high-quality assets, and are positioned to benefit from the energy transition. However, we believe the market does not fully appreciate the value of our assets,” Banskota stated in the strategic review announcement.

The board has created a Strategic Review Committee that includes three directors. It anticipates that the committee’s findings will be available by the second quarter earnings call in August.

The Renewable Energy Group’s operating profit in the first quarter was $106.5 million, down 9.7% from Q1 2022. (All figures in Canadian dollars unless otherwise specified.) Its profit was lower in the quarter due to reduced Hypothetical Liquidation at Book Value (HLBV) income and lower production from its renewable assets, offset by better results at its Texas Coastal Wind Facilities.

HLBV income is the hypothetical income it would receive were the assets of the projects it’s involved in were liquidated. For example, it owns 51% of its Texas Coastal Wind facilities.

As of March 31, the renewables segment had a net generating capacity of 2.4 gigawatts (GW). Approximately 82% of the energy produced from its facilities is sold via long-term contracts. The average life remaining on those contracts is 10 years. Nearly three-quarters of its renewable generation is from its facilities in the U.S.

Need for Separation

Scotiabank Global equity research analyst Robert Hope wrote in a note to clients last week that the move to spin off or sell the business makes sense because investors aren’t willing to pay a premium for complicated investments.

“Simplicity could be well-received by investors,” Yahoo Finance reported Hope’s comments in a note to clients. “In recent years, we have seen investors prefer simpler stories versus more complicated spinco/yieldco situations.”

While there may be operational reasons to keep the two segments together, the strategic review will likely find that they aren’t compelling enough for Algonquin not to proceed with a sale or spinoff.

After canceling its US$2.6 billion acquisition of Kentucky Power and AEP Kentucky Transmission Company in mid-April, Algonquin needs to do something definitive to boost its share price, down 39% over the past 12 months.

In the same period, SPDR S&P Kensho Clean Power ETF (US:CNRG) is up 11.8%. That exchange-traded fund has AQN stock allocated to 3.2% of its portfolio, with 1.2 million shares, according to data compiled by Fintel. It is the fifth-largest holding of the ETF’s 43 stocks.

RBC Capital Markets analyst Nelson Ng wrote about the situation late last week. Ng argued that Algonquin’s Regulated Services Group operating on its own becomes a regulated pure-play utility, which is easier for investors to value. But, unfortunately, it does so while sacrificing growth, which will appease dividend investors but scare away more growth-oriented investors.

The answer to whether Algonquin will be sold or spun off will become clearer in about 90 days.

This article originally appeared on Fintel

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