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Want Excellent Dividend Growth & a 5.4% Yield Today? Then Check Out Capital Power
Oh, and it's also one of the cheapest stocks on the entire TSX
I first encountered Capital Power (TSX:CPX) back in 2015 when Alberta’s then-ruling NDP government announced the province would move away from coal-generated power.
I was much more interested in TransAlta at the time, because that stock had been depressed for years and I thought it represented a quality deep value opportunity. I did end up buying TransAlta shares, getting in at a hair above $6. I got out a year or two later at $8 and change after losing patience with the turnaround story. Which, in hindsight, wasn’t such a bad move. TransAlta is trash. All the good assets will end up inside TransAlta Renewables. Mark my words.
Aside: that’s a very common problem with deep value/turnaround investing. It takes years to turn most of these turds around, assuming it ever happens. It’s hard to sit through quarterly updates full of optimism while the underlying numbers are tepid. Long-term investing takes patience too, but at least you get to look at improving financials as you wait.
While I was off chasing waterfalls, Capital Power was having an existential crisis. The company owned four huge coal-fired power facilities in Alberta, with the main three located just outside of Edmonton. These plants would either need to be converted to natural gas or abandoned by the 2030 deadline.
The good news was the three affected companies got compensated for being forced to shutter assets early. Capital Power, TransAlta, and Atco split $97M per year each year until 2030, with Capital Power’s share at $52.4M. That worked out to $734M in total payments.
The company was free to continue burning coal until 2030, too. It just needed to make the required changes by then. And that’s exactly what happened. Capital Power pocketed the money and it was business as usual, at least for a while. Genesee, the newer of the company’s coal-fired assets, didn’t even start to convert to natural gas until the 2020s. Meanwhile, $52.4M kept coming in, year after year.
CEO Brian Vaasjo was already implementing a plan to diversify the company outside of Alberta when the NDP made the fateful announcement, moving into more renewable sources of energy. After 2015-16 the company doubled down on its strategy, either acquiring or developing all sorts of assets across Canada and the United States.
These days, Capital Power owns 29 operating facilities, a diversified portfolio stuffed with newly built or acquired assets. It has a number of different development projects in the works, too. Capacity is approximately 7,500MW, with another 800MW coming online by 2024. Some of the new assets are in Alberta, but the expansion plans have largely focused on diversifying away from the province.
Here’s a look at a recent asset map.
There’s still quite a bit of action happening in Alberta, but most of the assets acquired since 2015 have been away from the province.
I’ve owned this one for a long time now, and have been recently adding more on the current pullback. Let’s take a closer look at why I’m so bullish.
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More about the growth story
The expansion plan has been two-pronged. Capital Power has acquired both natural gas and renewable energy generation assets over the last decade.
Here are some of the main deals:
2022 - Capital Power and Manulife spend US$894M to buy Midland Cogeneration Venture from OMERS, a 1,633MW natural gas facility in Michigan
2021 - Completed phases 2 and 3 of the Whitla Wind project in Alberta, adding 353MW. Also acquired a 1,300MW portfolio of 20 solar sites across the United States
2020 - Acquired 101MW wind facility near Dallas, Texas
2019 - Goreway Power, an 875MW natural-gas fired plant located in Brampton, Ontario for $977M
It also has big plans for its internal development portfolio. There are some 4,700MW of near-term growth projects identified. Here’s an asset map of where these projects will be located. Notice the large emphasis on storage.
Over the next 12-18 months the company will really be focused on repowering Genesee 1 and 2, which will be converted 100% to natural gas. Unit 2 should be ready to go by the end of 2023, while Unit 1 was recently pushed back to early 2024. I don’t want to underestimate what’s going on at Genesee; these improvements will add 512MW in capacity, for a total of 1,372MW for the whole facility.
There are also various solar projects that will be completed in 2024.
Between the new acquisition in Michigan and the Genesee expansions, earnings are projected to increase in 2023. And that’s even after what should be an excellent 2022. Current guidance is for AFFO (Capital Power’s preferred profitability measure, which is essentially free cash flow) to be between $770M and $810M for the year. Taking the low end of that range gives us $6.63 per share in AFFO.
The company hasn’t given us any AFFO guidance for 2023, but we do have adjusted EBITDA guidance of approximately $880-$900M for 2023. If we again take the low end of that range and convert it to AFFO (using last year’s EBITDA-to-AFFO conversion rate as a template), we get approximately $6.80 per share in AFFO for 2023. It looks like an increase in earnings, but not a huge one.
Still, not bad for a stock currently trading at around $43.
Yeah, that’s right. The stock trades at under 7x AFFO despite growing AFFO per share at 18% per annum over the last five years.
Look at this long-term EBITDA growth. It’s succulent.
So, why is the stock trading at such a low valuation despite the spectacular growth?
Let’s talk a little bit about the Alberta power market, essentially the wild west of power.
Alberta is completely deregulated, meaning power producers like Capital Power have a few different choices. They can sell power to the grid at market rates, which depend on supply and demand. Prices are higher during peak times. They’re not as high during low periods. They can also sign PPAs with various organizations, effectively locking in the price received. Or they can do a combination of the two and do their best to hedge.
The problem is much of Alberta’s power is consumed by big energy producers, specifically the oil sands. If they start to pull back production in any big way, power prices plunge.
Alberta’s power prices are currently much higher than the previous few years. What happens when they inevitably go the other way? There’s also new production scheduled to come online over the next few years, and not just from Capital Power either.
The company is hedging, but also doesn’t want to lose the upside if power prices stay high. It’s also hedging input costs as well, doing so well before natural gas took its most recent nosedive.
From its latest earnings presentation:
The other wart I can see is the debt keeps going higher. The company’s expansion plan has largely been fueled by increasing debt. There’s no way it can continue to add assets at this rate if it just counts on internal cash flow.
Take a look at the debt over the last five years, courtesy of TIKR:
Most of it is long-term in nature too, locked in at lower rates.
$3.5B in total debt and less than a third comes due before 2029. That’s a good place to be in.
There are also approximately $750M in preferred shares outstanding, which are effectively debt. These are essentially perpetual debt and will be treated as such.
So yes, debt has gone higher in the last few years, and the company will need to borrow to help fund its expansion plan going forward. But I think it’s a very manageable problem.
Capital Power has consistently raised its payout for more than a decade now, increasing its annual payout from $1.26 per share in 2013 to $2.32 per share in 2022. That averages out to a 7% annual growth.
The Board of Directors have committed to increasing dividends by 6% annually through 2025, with a targeted payout ratio of 45% to 55% of AFFO. As it stands today, the payout is approximately 40% of AFFO.
There are very few stocks that can offer the unique combination of high yield today (shares currently yield 5.4%) and the potential for solid dividend growth going forward.
Even though I hate yield on cost, let’s run a little experiment. Let’s assume the company can increase dividends by 6% annually until 2030. How does that compare to today’s price?
Yeah. I’ll take that.
The bottom line
Like Polaris Renewable Energy last week, Capital Power is a legitimate growth story trading at a dirt-cheap valuation. I understand why Polaris is cheap, because it operates in Latin America. But Capital Power doesn’t have any of that political risk, yet it’s almost as cheap. I simply don’t get it.
What I really like about this one is there’s two ways to win. You can either make money by the company hitting its growth targets and staying at the same valuation or by multiple expansion. Combine the two and it could be a big winner.
I also think this one could be a nice acquisition target. It checks off all the boxes — good management, solid growth, and a cheap valuation. Even if the acquirer has to pay a premium to get the deal done.
I recently added a little more and have made this name a top-10 position in my portfolio. I’m happy to sit back, relax, and wait for this name to work out, adding to my position during any big dips.
Disclosure: Author owns shares of Capital Power