Thursday, January 19, 2017

ATCO Ltd. - 24 Years of Dividend Growth

Of the top four companies with the longest annual streaks of dividend increases found on the Canadian Dividend All-Star list, three are in the utility industry. After reviewing both Canadian Utilities Limited and Fortis Inc this post will give an overview of ATCO Ltd. which has a 24-year dividend growth streak.

Company Overview

ATCO Ltd is a Calgary-based utility company with global operations falling into three segments: electricity (46% of YTD revenues at Q316 ), pipelines and liquids (36%), and structures & logistics (18%). ATCO holds controlling interests in Canadian Utilities Limited (52.9% ownership) and ATCO Structures & Logistics Ltd. (75.5% ownership).

Dividends

After announcing a 15% dividend increase on January 12, 2017, the company's dividend yield is currently ~2.9%. The earnings payout ratio is moderate at 55% of the trailing 12 months EPS.  The 3, 5, and 10 year dividend growth rates are very impressive at 15%, 15%, and 10.8% respectively.

Valuation

The current share price of $45 has lead to a trailing P/E of 22X. This value is relatively high given the stock has traded in the 12-14X range for most of the past 5 years. Looking at EV/EBITA leads to a similar conclusion, with the company currently trading at 8.1X in contrast with their 5-year average in the 7-8X range.

Qualitative Catalysts

There are some key reasons why you would consider adding ATCO to your investment portfolio

1. Dividend Growth & Coverage
- The recent 15% dividend increase from ATCO represents the sixth consecutive year that management raised the payout by 15%. With a relatively low payout ratio for a utility company of 55%, the dividend is well covered. Planned capital expenditures of $3.8B over the next two years should help ensure that the dividend continues to grow in the future.
2. Capital Investments Leading to Higher Cashflow Generation
- With a plan to invest $5.3B in regulated utility and contracted capital growth projects between 2016 and 2018, it bodes well to see that past capital investments have led to growing cashflow from operations over the most recent five years. Although past experience is not indicative of future results, it is encouraging to see that the company's growth aspirations are supported by past success.
3. Diversification Gained Through Holding Company Structure
- Compared to the two companies in which they hold controlling interests (Canadian Utilities Ltd. and ATCO Structures & Logistics Ltd.), ATCO provides further geographic and product diversification to a potential investor. The added diversification should lead to smoother cashflows over the long-term, which seems to be the case when comparing ATCO's financial results to those of Canadian Utilities Ltd.


Qualitative Drawbacks

Beyond the fact that the current valuation of the company's shares seems high from a historical perspective, there are some additional drawbacks for investors to consider before adding Canadian Utilities to their investment portfolio.

1. Financing Needed for CAPEX
- With ATCO's aggressive capital expenditure program over the next two years, the company will need to continue to access the debt and capital markets. This financing will result in higher leverage and shareholder dilution. Over the last five years, the company has issued approximately $4.5B of net additional debt in order help fund their CAPEX.
2. Regulatory Risk
- Being involved in regulated businesses entails the risk that future regulatory decisions outside of the company's control could materially impact ATCO's' operations and results. For instance, in October 2016, the Alberta government set the maximum return on equity rate that ATCO could earn on their regulated electricity assets in that province at 8.3% in 2016 raising slightly to 8.5% in 2017. ATCO's regulated assets in different geographical locations adhere to similar capped rates of return.
3. Complexity of Holding Company's Operations
- While reviewing financials for ATCO, I could not accurately determine the amount of their assets subject to regulations, nor could I determine the geographical diversification of their sales. Such is often the case for holding companies whose financial statements are more difficult to understand due to complex financial reporting requirements.

Conclusions

Of the three utility companies I have recently reviewed, I find ATCO the most compelling. Not only do they have a relatively low dividend payout ratio at 55%, their six straight years of dividend growth of 15% and their diversified operations are all strong factors in support of the company. The major downside I see currently is that their valuation is very high by historical standards. Any prolonged weakness in their share price could very well lead to a situation where ATCO would be an excellent long-term utility investment.


What would make you consider adding shares of ATCO Ltd. to your portfolio?

2 comments:

  1. Nice analysis. I do not own ATCO, having decided to go with Fortis and Algonquin in that space. However, I did pick up Canadian Utilities for my wife's account in early 2016 at just over $32. Since then it has generated a 15% return plus the dividend (which as you know has been rising for over 40 consecutive years.
    Thanks again for the analysis.

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    Replies
    1. Congrats on the strong return on CU! I'm looking forward to reviewing AQN later this year.

      Thanks for your comment!

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