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12/28/22 Capitalist Times Live Chat
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AvatarRoger Conrad
2:06
saga now goes a bit deeper with the FERC (Federal Energy Regulatory Commission) rejection of the Kentucky Power acquisition. I’d like to hear your impressions regarding:
 
1. How committed (stubborn) do you think management will be in pursuing the deal? I believe you said in your CUI+ update that their first comments indicated they planned to pursue it. But you had also said the specific FERC justification for rejection was basically a new, impossible standard to meet (i.e. cost of capital cannot go up). Doesn’t this mean the deal is a dead weight, particularly as the cost of keeping the cash ready for the acquisition has been what’s caused profits/cash flow to suffer? You’ve said for years that you’ve been impressed with AQN management. What might you expect now? Will they accept new reality and make needed adjustments to right their operations (give up on deal, settle variable debt, possibly cut dividend, maybe buy back beaten down shares, focus on lower-resistance growth investments), or will they be
2:07
stubborn and stick to this deal and perhaps also insist they must maintain their dividend aristocrat status? This set of choices is what management gets paid for.
 
 2. Regarding AQN valuation, business prospects, is there any reason not to expect a recovery on a 5- or 10-year timeline? I can wait. Finding electric etc utilities at these valuations is nigh on impossible, and recoveries for adequately managed regulated utilities are supposed to be predictable. Any long-term concern? Is there still a solid growth runway with the renewables and new IRA incentives?

3. AQN as buyout candidate? Trading below book value, a collection of assets and capital-intensive growth avenues suffering from challenged financing…. Isn’t this where someone like Brookfield would be ready to pounce? Standard operating procedure: all the assets and projects are more profitable to the deep-pocketed purchaser who can recapitalize on better terms and weather short term challenges.

And closing, I thank you for your editorial choice in
the last issue to look at the debt structure for all companies in the coverage universe. That was timely and helpful. Sincerely--Dan N.
 
A. Hi Dan. I’m glad you found my December CUI issue deep dive on utility company debt helpful. I hope everyone will check it out as the longer the Fed keeps pushing up interest rates, the more of difference maker balance sheet issues will be.
 
Starting with your first question, I would preface my answer with the fact that anything I say is basically speculation. For anyone not familiar with its history, Algonquin started out as a Canada-based power plant developer organized as an income trust in the early ‘00s. They made a strategic decision mid-decade to convert to a corporation and follow other Canadian energy companies into the US--by investing in regulated electric, natural gas and water utilities. They converted their contract electricity generation business in renewable energy in the following decade. And a few years ago, they added the third piece of the business,
which is a 42.49% ownership interest in Atlantica Yield. Every asset addition increased the scale of the business, and thereby enhanced the company’s ability to grow.
 
I have been a big fan of Ian Robertson, the architect of Algonquin’s growth strategy, having spoken to him on several occasions including Edison Electric Institute Financial conferences. He retired in early 2020 and was replaced by the current boss Arun Banskota, who has largely continued the growth strategy—but with a greater emphasis on utility rate base investment including coal-for-wind generation replacement. I also believe he’s brought more of a button down approach to running Algonquin, which under Robertson had a more aggressive approach. And this is the mindset I think decisions will be made under, which we should see when the company releases its new guidance early next year.
 
The company obviously has two major challenges to address. One is the balance sheet and the large amount of variable rate debt they hold. The other is whether
2:08
they want to keep trying with FERC. The text of the decision rejecting Algonquin’s purchase of Kentucky Power is available on the FERC website. And while there’s a lot one could read in there, the Commission did explicitly cite the company as not providing enough proof to the effect that cost of capital concerns would not affect customer rates. I do believe this is a departure from past FERC decisions on utility mergers. The Commission’s makeup is in flux with Chairman Glick unable to get past Senator Joe Manchin’s (D-WVA) opposition to win a new term and apparently resigning in January. His replacement could result in someone more favorable to utility mergers. But a short-handed FERC has also historically not made fast decisions—and this one will have 2 Democrats and 2 Republicans at a time of political polarization.
 
It’s entirely possible the company is closer to working a deal with FERC than is indicated in the text of this decision. And my view is they’ve put a lot of effort into this deal and would
want to close it. But that said, walking away would reduce a lot of financial pressure on Algonquin. And if it were paired with an asset sale—for example the ownership stake in Atlantica Yield that’s right now worth about $1.3 bil—it would greatly reduce the need to roll over short-term and variable rate debt. That would also greatly reduce pressure on the dividend. Conversely, if they keep pushing on this deal, they will likely have to take more aggressive moves elsewhere, which could mean a dividend cut.
 
Bottom line is I could see management going either way. And one reason for swapping the common shares for the convertible preferred is to maintain income either way. Addressing your second question, I do think the stock is trading at an extreme valuation, pricing in a very worst case scenario. And I think the business model of combining regulated utility franchises with a smaller contracted renewable energy business is still very sound—particularly given the large amount of subsidy but also the fact that
the price of fossil fuel generation has become very volatile. And utilities that have debt problems have historically been able to work around them over a period of years.
 
As far as a takeover, I think that’s possible as well, though a Canadian utility like Fortis Inc (TSX: FTS, NYSE: FTS) could be a better candidate as there are more complementary structures. Probably more likely, however, would be asset sales, which management has already shown some skill in executing.
 
Bottom line is I think Algonquin should still prove to be a good investment long-term. What’s changed over the past year is it’s no longer suitable for risk averse investors. That’s largely the result of not being able to close Kentucky Power in a timely manner. Had they made the original anticipated date of Q2 2022, they would have had time to permanently finance everything without taking on such high levels of variable rate debt. And with hindsight, missing that date combined with where the Fed was going with interest rates
2:09
was a warning that the company was going to hit some pretty severe near-term headwinds.
 
Obviously, I can’t do anything about that now. And my personal position in Algonquin is now deep in the red like everyone else’s. But I think the swap of common stock for the mandatory convertible preferred I advised in the Alert we sent yesterday is a good way to ride out the near term—while preserving income and continuing to bet on recovery.
 
The big risk in staying with Algonquin preferred or common stock is that there’s something management isn’t telling us and is not in the extensive financials on the SEC’s EDGAR website, or another headwind emerges that’s beyond their ability to remedy. And while I like the course of action I’m recommending, I can’t rule any of those possibilities out entirely. That’s why no one should overweight it or any other stock, no matter how cheap it looks.
Sohel
2:21
Hello Elliot,  Based on past history and the current situation, what is your current outlook on the Energy sector bottoming vs the overall stock market. Before, at the same time as or after?
AvatarElliott Gue
2:21
I see energy as a likely leadership group for the market over the next 5 to 10 years. Historically, budding leadership groups bottom out ahead of the broader market and show strong relative strength in the later stages of a bear market. In the 2000-02 cycle, for example, energy bottomed out about 3 to 4 months before the broader market and outperformed the S&P 500 by around 8 percentage points in the final 6 months of the bear market. In 2007-09, technology bottomed almost 5 months before the broader market and outperformed the S&P 500 by over 9 percentage points in the last 3 months of that bear market.  Maximum declines from budding leadership groups also tend to be lower than for the market as a whole measured from bull market peak to bear market trough.
Guest
2:34
Hi Elliott,

Where do you think SLB stock is going in the next 1-2 months?  Will the recession cause it to fall like you anticipate with other EIA positions or is it in a separate situation where the prospects are so good that it will continue higher even if other oil stocks fall?
AvatarElliott Gue
2:34
I'd honestly be very surprised if SLB could rally amid a major sell-off in the broader market and the energy sector. In the most intense phase of  a bear market, virtually all stocks will fall in value in sympathy with the market. However in a steady downtrend environment, such as we've see in recent weeks, I believe SLB can buck the overall trend and outperform both the S&P 500 and most other energy stocks. And, longer term, we believe SLB is one of the best-placed energy stocks in our coverage universe, which is why we didn't recommend selling any from the model portfolio when we did trim some of our exposure in other energy names over the past month or so. We see dips in the stock mainly as a buying opportunity.
john c
2:40
XOM has had a great run this year.  a good time to sell?  Expect a pull back later for another buying opportunity?
AvatarElliott Gue
2:40
XOM remains one of our favorite long-term energy holdings due, in large part, to their decision to invest counter-cyclically in the past 8+ years. In other words, they took advantage of lower oil and gas prices -- and a better development cost environment -- to invest in new projects that are now paying off in the form of rising free cash flow. Many of their peers pared back capital spend for various reasons, resulting in less growth potential now that commodity prices are more favorable. Despite the solid fundamentals and long-term outlook, in late November, we recommended paring exposure to XOM by selling off about 25% of the position in the model portfolio for a sizable gain since recommendation. We do believe there will be some additional selling pressure in energy in early 2023 amid broader market weakness and we would be looking to add back exposure to names like XOM on dips in price in 2023. We believe intermediate-to-long-term gains (say 3 years out to 5 to 10 years) will be stellar for XOM.
Barry J
2:40
Hi Roger:

What is the reason for BEP continuing to hit new 2 year lows of $24.42/sh?

It traded today as low as about 30% below your Dream Buy Price of $35/sh. Does this make it even more attractive to purchase now?

Thanks.
AvatarRoger Conrad
2:40
Hi Barry. I think Brookfield Renewable Partners (TSX: BEP-U, NYSE: BEP) and it C-Corp shares (NYSE: BEPC) are down this year for several reasons: They priced in Canadian dollars though pay dividends in US dollars, 2. There's piling on now as investors sell losing stocks, particularly institutions resetting portfolios. 3. Renewable energy stocks including those that have consistently made money are under pressure. 4. The company is in the process of making several large acquisitions at a time when investors are understandably concerned about rising interest rates. Encouragingly, the analyst community hasn't wavered in support, the company's credit ratings have been recently affirmed and insiders have been net buyers. The company has had no trouble raising capital with help from parent Brookfield. And a dividend increase is likely in February. I never recommend really loading up on any one stock. But I am comfortable sticking with BEP long-term.
Jeffrey H.
2:47
Hello again Gentlemen, I have two more questions for you. First, do you think the almost 7% dividend of AY is justified -- will it be cut? Also, do you think EMRAF will thread the needle of its debt obligations without cutting its dividend, which also is quite high (5% or so)?  Thank you again for you again for your valuable advice.
AvatarRoger Conrad
2:47
Hi Jeffrey. Thanks for participating today. Dividends are always at the discretion of management and the Board. But there's certainly no pressure on Atlantica Yield to cut its dividend now. Debt, for example, is almost entirely at the project level and amortizes every year, reaching zero before existing contracts on the assets expire--so there is no concern about funding maturing debt. In addition, contracts are with creditworthy counter parties and protected from currency  fluctuations. Floating rate debt is also hedged against rising rates and 50% of the portfolio has inflation escalators. Add to that they're just coming off a very solid Q3. As for Emera, they just increased their dividend for the November payment. I disagree they're "threading the needle" to maintain their dividends--especially now that there's a rate agreement in Nova Scotia that appears amicable. High yields don't always connote dividend risk.
Bur D.
2:53
Question for webchat, centered around the recommendation to swap AQN for AGNU:

1. Given the 16 dec FERC decision (https://www.tdworld.com/utility-business/article/21256601/ferc-turns-d...), is the Kentucky Power acquisition less likely to go through?

2. If the deal fails, does that leave AQN in a better or worse position than today?

3. What sacrifices might AGN have to make to complete the deal?

4. Your AQN-to-AQNU swap idea is interesting, but are there perhaps other ideas which might give the same 19% return (14% XIRR) over the next 18 months?

Thanks
AvatarRoger Conrad
2:53
Hi Bur. I've pretty much written a book on Algonquin in my answers to pre-chat questions, as well as in the Alert we sent last night and in other Alerts and recent issues of CUI. I won't repeat what I said there but briefly I think the FERC decision does possibly doom the Kentucky Power acquisition, which will mean less growth the next few years but also a much reduced need to finance short-term debt. I've posited selling assets as one way Algonquin could continue pursuing the deal, including the ownership interest in Atlantica Yield.

As for question 4, I believe the stock market is facing considerable headwinds at least in first half 2023--as the Fed continues to raise interest rates and recession risk rises. But I think all of the stocks in the CUI portfolio are capable of generating strong returns.
Frank D.
2:55
Thanks for your great advice. The energy stocks you recommended have saved my portfolio this year. A friend recently suggested Coterra Energy (CTRA) to me. What do you think about it?
AvatarElliott Gue
2:55
Thanks for the kind comments and the question. Coterra Energy, formerly known as Cabot Oil & Gas (COG), was formed via the acquisition of Cimarex Energy by COG. Generally we like the name, which holds a combination of acreage in the Marcellus (natgas) region of Appalachia and the Permian region (more oil-focused). Overall, however, CTRA is more leveraged to gas than oil. It's a quality producer with low cost acreage. That said, we prefer CHK. CHK is also a gas producer and based on current and our estimates for natgas prices in coming years, we think CHK is in a position to generate some $2.5 to $3 billion in free cash flow annually over the next few years. That means it generates enough free cash flow to exceed the current value of the stock (market cap) in less than 5 years. On this basis -- likely FCF over the next few years -- CHK looks cheaper to use than CTRA and a better value at current levels.
Eric
3:03
Happy holidays and thanks for doing these chats!  Why is BEP underperforming renewable energy indexes like ICLN and utilities like XLU in the last couple of months? More sensitive to a recession or rising interest rates? Lower oil prices as a competitive substitute? Tax loss selling? Dislike of the Westinghouse deal? Others?
AvatarRoger Conrad
3:03
Hi Eric. I think the fact Brookfield and parent Brookfield Asset Management are aggressively making acquisitions accounts for the weakness. And I think they're going to have to demonstrate deal economics before investors will come back to them. That includes ability to get them approved by regulators as well as to fund them. I think the fact they're going into nuclear with the Westinghouse deal might have caused some "green" funds to pare back as well. But that said, BEP is putting its money where its mouth is buying back its shares at these prices--and as I pointed out earlier in the chat there's insider buying.
Guest
3:06
Hi Roger, Thanks for holding these chats - incredibily useful. What's the symbol for the convertible preferred you recommended above: "swap of Algonquin common shares for its 7.75% convertible preferred".
AvatarRoger Conrad
3:06
You should be able to buy it under the symbol "AQNU." The Cusip is 015857873. But the important thing is to make sure there's an indication of 7.75% Preferred of 06/15/24.
Bonnie Beth
3:10
Hi Roger, great to be here.   I own 110 shares of AQN at approximately $14.25 average.   I saw in your alert that you said to swap AQN for AQNU preferred.   What to you suggest?  I am down about 50 - 55%, so should I sell and buy the preferred now, or hold my current position in AQN?
AvatarRoger Conrad
3:10
Hi Bonnie. My recommendation per the CUI Alert is to sell the Algonquin common now and use the proceeds to buy the AQNU preferred. You will take a loss that can be used against capital gains. But you'll get a higher and safer yield--since the preferred has far less risk of being cut than the common now. And you'll still be betting on a recovery in the common--since the preferred converts to the common in June 2024. I'm not advising committing fresh funds to the preferred--just what's still in the common.
Frank
3:11
Roger - With your recent comments in CUI+ about purchasing in thirds, do you apply that to the swap from AQN to AQNU or no need to wait? Happy new Year to you and Elliott an sincere thanks for great research and advice.
AvatarRoger Conrad
3:11
Hi Frank, no that's just a straight up swap I'm recommending. Good question. And Happy New Year to you and yours!
Terry
3:12
The yield curve is inverted because of the expectation the Fed will eventually cut rates. How does quantitative tightening factor in? In addition, much has been lost in the equity and bond markets, and crypto is down a trillion plus. So there is a lot less money to invest. Also, the US$ may lose its attractiveness to foreign investors. Wouldn’t these factors tend to keep long term rates higher for longer?
AvatarElliott Gue
3:12
In my view there's no entirely satisfactory way to equate QT to changes in interest rates. I do believe it's important to watch the level of Reserve Balances banks hold at the Federal Reserve, which is part of the weekly H41 release by the Fed. As QT proceeds, this has the effect of draining bank reserves, which have fallen from a peak of $4.28 trillion a year ago (December 8, 2021)  to just under $3.1 trillion today. Estimates differ, but as we start to get under $2.5 trillion or so, we'd be back to 2016-18 reserve balance levels, which I'd suspect could start to impact the US credit/financial system more severely.  An inverted yield curve reflects a market view that the Fed's monetary stance is tight -- short rates are higher than long term average interest rates and the neutral rate. As the US economy slips into recession, I'd expect the yield curve to steepen rapidly -- that happens because the Fed cuts short rates, which fall faster than long-term interest rates. The inversion of the yield curve doesn't
AvatarElliott Gue
3:12
really tell us anything about the longer-term level of long-term US Treasury yields. For example, if you believe the Fed will pivot quickly in early 2023 to combat a weaker economy then that implies a flatter curve. That's bullish short term rates (2-Year bond yields fall, prices rise). It could be either bullish or bearish the 10-year -- when the yield curve steepens it can happen because: short-term rates fall faster than long-term rates, long-term rates rise more than short term rates or some combo of rising long term rates and falling short term rates. In recent cycles, however, when the stock market sells off, investors often gravitate to the safety of the bond market, which means 10-year yields fall albeit at a slower pace than short-term yields. Generally, my view is that long-term bond yields will remain higher than  has been the case in recent years, but I still see the potential for a significant safe haven trade into bonds next years as money comes out of stocks and is reallocated to bonds.
Dan
3:17
Hi Roger, thanks for the heads up on OKE in the Utility Investor e-mail.  Does KMI and EMB also fall under the same caution of recession? or would those names be OK to reinvest the OKE proceeds?  Thanks and have a great new year.
AvatarRoger Conrad
3:17
HI Dan. And Happy New Year to you. No, Kinder Morgan (NYSE: KMI) and Enbridge Inc (NYSE: ENB) are considerably larger and more diversified than ONEOK Inc (NYSE: OKE). They're also both generating considerable free cash flow after dividends and expect to do so in 2023--which means a much bigger cushion for dividends and no real balance sheet pressure. Also notably, both Kinder and Enbridge are raising dividends.

As for a replacement, I think either Kinder or Enbridge are suitable. But keep in mind that its also good to have some cash going into a year when prices are likely to be lower a few months hence. And as I've written, I'm a fan of buying incrementally in this environment rather than taking positions all at once.
Lee
3:17
Happy Holidays, Roger and Elliot, and again, many thanks for hosting this valuable venue.
AvatarRoger Conrad
3:17
Thanks Lee. And Happy Holidays to you as well.
Michael C.
3:23
I’ve noticed that industrials (XLI) have broken their 5-year downtrend vs. the SPX. As we look ahead to the next bull market, are there any industrials you’re watching for inclusion in the model portfolios?
   Just over a year ago, Elliott outlined the “coming lost decade” thesis, with the notion that the 1970s (or ‘00s) look like probable precedents, with short, powerful bull markets and short, powerful bear cycles. I’m curious what you think, a year later.

Thanks again to everyone at CT, and wishing you a happy and healthy new year!
AvatarElliott Gue
3:23
Thanks for the question. I actually just sent out an issue of my Creating Wealth service focused on just that issue -- the long-term outlook for stocks. Simply put, valuations are by far the most important/powerful long-term stock market indicator -- historically, market valuations can explain 70% to 80% of 10-year forward stock market returns. I generally use some version of Normalized or averaged earnings to assess valuations and, I can tell you, that at current levels the S&P 500 is still very expensive. It's obviously impossible to be exact but a simple regression of the S&P 500 P/E ratio using 10-year averaged earnings suggests investors can expect nominal market returns (before inflation) of less than 7% annualized over the coming decade. Depending on inflation -- which I expect to be higher than over the last 20 years -- then I think those returns could be paltry in real terms. The situation over the past year is very similar to the late 60's early 70's and late 90's early 2000's, which preceded
AvatarElliott Gue
3:23
prolonged periods (10+ years) of below-average stock market returns (actually negative real returns in both cases). Lost decades for the S&P 500 tend to be periods of shorter market and economic cycles -- strong rallies and nasty bear markets amid a sideways trading environment. Such periods also tend to mark episodes of asset reallocation and shifting market leadership. I suspect that's happening right now, which is why you're seeing value groups like energy and, as you note, industrials show strong relative strength. I also believe commodities like gold/energy and smaller stocks look attractive on a relative valuation basis to the tech and growth-dominated S&P.  I would be shocked if the Industrials don't come down alongside the S&P 500 in 2023 -- they are cyclicals after all -- but I do believe there will be buying opportunities in select names next year as the market eventually approaches a bottom.
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