Mike, Author at MOOSE MARKETS

Buy List Stock for April 2024: Hammond Power Solutions (HPS.A.TO)

New to my buy list for April 2024 is Hammond Power Solutions (HPS.A.TO). This pick is a speculative play. While Hammond Power is a small-cap company it might be the underdog investors didn’t see coming. It’s an interesting play with a good dividend if one is not afraid of market fluctuations. Hammond is still experiencing significant growth.

See also our U.S. buy list stock pick for this month.

Get great stock ideas from our Rock Stars list.

Hammond Power Solutions Business Model

Hammond Power Solutions Inc. is a manufacturer of dry-type transformers in North America. It engineers and manufactures a range of standard and custom transformers that are exported in electrical equipment and systems. It enables electrification through its range of dry-type transformers, power quality products, and related magnetics. Its standard and custom-designed products are essential and ubiquitous in electrical distribution networks through a range of end-user applications.

The company’s products include power transformers, furnace transformers, converter transformers, unitized substations, control & automation products, low voltage distribution products, medium voltage distribution products, and others. It supports industries, such as oil and gas, mining, steel, waste and water treatment, commercial construction, data centers, and wind power generation. It has manufacturing plants in Canada, the United States, Mexico, and India and sells its products around the globe.

HPS.A.TO Investment Thesis

Hammond Power is a small-cap company with a market cap of approximately $950M that competes against many giants in the industrial field. The company enjoys a solid reputation for the quality and reliability of its. HPS tried to expand its success internationally but had to close its Italian division and continues to struggle in India. However, after closing its Italian business, the company focused on what’s working for it in North America.

The company is now well-positioned in Mexico and exhibits growth potential in both Mexico and the U.S., which now represent more than 50% of its total revenue. Hammond continues to witness significant growth in its custom business in the energy, mining, silica chip manufacturing, and data center markets.

HPS.A.TO Last Quarter and Recent Activities

Hammond Power Solutions 2023 results showed robust growth across all geographies and channels. Its most recent quarterly results were strong, again, with revenue up 30% and EPS up 10%. The quarter ended with record shipments of $187M globally. This was a new record top line, which helped the company reach its margin and profit targets.

U.S. and Mexico sales were helped by a stronger U.S. dollar relative to the Canadian dollar compared to 2022. HPS saw substantial sales growth in the OEM channel in the U.S. in support of data centers, warehousing, industrial manufacturing, mining, electric vehicle charging, renewable energy, and oil and gas production. The company will continue to invest in increasing its capacity for 2025. This is looking good!

Graphs showing Hammond Power Solutions (HPS.A.TO)'s stock price, revenue, EPS, and dividend over 10 years — Monster growth for Hammond Power Solutions (HPS.A.TO)

Potential Risks for Hammond Power Solutions

The pandemic had an impact on HPS as revenues decreased due to the deferment of electrical projects, business interruptions, and overall lower levels of economic activity. However, HPS proved its resilient business model, with orders rebounding and HPS skyrocketing.

We advise you to tread carefully with small caps that are growing too quickly. HPS’ expansion success in North America couldn’t be replicated in India or Italy. After closing its business in Italy, future expansion projects may not spark investors’ enthusiasm. Also, a part of the company’s revenue is tied to the oil & gas and mining industries, both of which are highly cyclical. HPS is also subject to currency fluctuations due to its exposure to the U.S. and Mexican markets. With such a small capitalization, an investment in this company can fluctuate frequently.

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HPS.A.TO Dividend Growth Perspective

HPS finally resumed its dividend growth policy in 2022 with a generous increase. The dividend went from $0.085/share to $0.10/share (+17.6% increase!) and then to $0.125 (+25%!) in early 2023. However, remember that the company chose to cut its distribution following the financial crisis of 2009, with more cuts in 2011-2012. The dividend remained stable for several years before the recent increases.

Unfortunately, the dividend growth policy will follow industrial economic cycles. In the meantime, you can enjoy the ride! Speaking of which, management increased HPS’s dividend by another 20% in September 2023.

Final Thoughts on Hammond Power Solutions (HPS.A.TO)

Hammond Power Solutions has shown amazing growth for the last two years. With a recession possibly around the corner, its customers in cyclical industries might not do very well themselves. Is HPS resilient enough to keep that growth going or will headwinds slow it down? Only time will tell.

Obviously, you don’t bet the house on this, but it could be a very lucrative investment, as long as you can live with significant volatility.

Interpreting a Weak Dividend Triangle – Part 2

Worried about holdings that show a weak dividend triangle? Revenue and EPS are falling, dividend growth is slowing down, or worse absent. What do you do? Last week we explored how to analyze falling revenue in a weak dividend triangle. Now we look at interpreting weak EPS and dividend growth.

In last week’s article, we explained the importance of putting metrics fluctuations in context and that the trend is your friend, meaning you must look at the evolution of metrics over time to understand what’s going on. Missed it? Read it here.

When earnings per share (EPS) are down

Earnings going down means the company is making less profit, not something that you like to see. Again, however, you must put that in context.

First, understand where that number comes from. EPS is based on accounting principles. Consequently, major events like impairments, one-time charges for an expansion and acquisition, and amortization impact the EPS even though these events aren’t necessarily bad things. Seeing the EPS go down raises a flag regardless, and it must be investigated. Reviewing the trend in Adjusted EPS (also called non-GAAP) can help here because one-time charges and amortization are not included.

Companies that make a lot of investments in assets or infrastructure have a lot of amortizations, and their EPS fluctuation often causes confusion.

Example: Brookfield Corporation (BN.TO / BN)

Recently, at the same time Brookfield Corporation (BN)’s EPS was going down, it announced a generous dividend increase. A business whose profit is plummeting is raising its dividend. “I’m losing my job I think I’ll buy a car.” It doesn’t make sense.

Since BN makes a lot of investments, it’s better off to look at funds from operation (FFO) and FFO/share rather than EPS. The FFO/share is at homemade metric and is not always easy to find. Financial websites show the adjusted EPS or EPS; digging into the quarterly statements and investor presentations will give you the correct picture. For Brookfield, they showed a company that’s growing and thriving, but EPS isn’t showing that profit yet.

Find stocks with a strong dividend triangle from our Rock Stars list, updated monthly!

Example: TD Bank (TD.TO /TD)

Another example from last year was TD Bank which had lots of one-time fees in its financial statements.

Fees for TD’s decision to abort the acquisition of First Horizon, a prudent move in light of many U.S. regional banks having problems with their balance sheets, and some of them going bankrupt in 2023.
The FDIC, which ensures deposits in the US, requested a special assessment of all banks in the U.S. As TD does a lot of business there, it spent $100M for FDIC assessment, passing the stress test and proving it’s well capitalized and has a robust balance sheet
Due to the economy, all banks had to raise their provisions for credit losses.

Combining these three unrelated factors hurt the EPS, whose trend doesn’t look sharp right now.

Graph of TD's dividend triangle that shows weakening EPS but steady dividend growth — TD EPS fell, but dividend growth is still there

Yet TD kept increasing its dividend last year and will continue in 2024 why? While the one-time events hurt the business, going forward, we’ll forget all about those as the business will thrive.

What about dividend growth slowing down?

Slowing dividend growth is usually the result of the rest of the dividend triangle; it’s rare to see a company with a high single-digit to double-digit growth for revenue and earnings whose dividend growth is slowing down.

If you see a dividend increase slowing to 3% and then 1% after being at 6% over 3-4 years, chances are both revenue and earnings were slowing down before that. It is prudent management to slow dividend growth rather than bleeding a balance sheet to death just to pay shareholders, but it’s also a red flag.

Find stocks with a strong dividend triangle from our Rock Stars list, updated monthly!

Can the payout ratio help to assess dividend growth health?

Yes, definitely. When the dividend triangle is weakening and the dividend growth is slowing down, the payout ratio is probably rising. Now we’re looking at the Sell button on our dashboard. However, it’s important to look at the appropriate payout ratio. There’s the classic payout ratio based on earnings. As I said earlier, earnings are based on accounting principles, not on cash flow. You should be mindful of that.

The cash payout ratio is an interesting metric. It’s based on free cash flow, so it does not consider the company taking on more debt to finance capital expenditures. For a capital-intensive business, the cash payout ratio is not perfect either. Instead, use the funds from operation FFO payout ratio. You could also simply compare the company’s dividend per share with the amount of Distributable Cash Flow (DCF) per share to see if there is room there for future dividend growth. See The Different Payout Ratios – A Quick Tour for more details about them.

Again, context is essential. That said, a weak dividend triangle and a payout ratio getting higher starts to scare me a bit more and bring me closer to selling, but I’ll do more research.

What other metrics can help understand a weak triangle?

When I’ve established that I’m concerned about a stock’s triangle, I start by looking at the cash from operations metric, because cash is closely linked to the ability to pay a dividend.

I also look at the long-term debt trend. If the debt keeps rising, and the payout ratio is above 100%, the company is leveraging its future; it better succeed in bringing profit and cash flow to the table and later because if not, it’s literally financing its dividend.

Growing debt can be understandable when there are large projects to fuel growth; the company is financing its projects and using its cash from operations to pay dividends. However, this situation cannot be sustained for a long time. It can last for a few years, but at some point, the company must stop adding debt and pay some of it down.

What’s next?

If after looking at these two sets of metrics (the three dividend triangle metrics, and the payout ratio and debt), I feel it might be fine to keep the stock, I do more qualitative research. The goal is to understand more about what’s wrong with the business model. Is it the economy hurting the business? Competitors? Can management resolve the problem? Has management said it was addressing the problem during the earnings conference call? If they just ignore the problem, that’s another source of concern.

For how many quarters should we tolerate a downtrend?

It’s not so much about a set number of quarters, but rather the reason why the metrics are slowing down. If it’s due to an economic cycle, like a recession that causes many companies in the consumer discretionary to have even two years of bad results or poor growth. Knowing that it’s normal in a recession, I would not sell after one year. However, if it’s because the business is losing market share and not finding ways to improve over several quarters, then it would be getting close to my sell list.

Interpreting a Weak Dividend Triangle – Part 1

Do you have holdings showing a weak dividend triangle? Revenue or EPS is stagnating or falling, dividend growth is slowing down, or worse there is no dividend growth. Do you sell right away? Not so fast. First, interpret the weak dividend triangle to know what’s really happening and make the correct decision.

What’s the dividend triangle again?

The dividend triangle is a tool I’ve been working with for over ten years, successfully and it forms the basis of my investment process. The dividend triangle includes three metrics: revenue, earnings per share (EPS), and dividend.

The key to my investment strategy is to find companies that are capable of growing their revenue, either organically or by acquisition, but that constantly find ways to grow their sales. As investors, we want to invest in thriving companies. A company that found a way to grow its sales year after year is the first thing I look for.
Next on my list that, as an investor, I want to see in a company is more and more profit. Earnings per share track that. Every year, I want to see a company with more sales and higher earnings per share.
After finding this magical Unicorn—well, truthfully, many companies show strong revenue and earnings growth—the next factor I want is for the company to reward its shareholders with yearly dividend increases.

Get great stock ideas from our Rock Stars list, updated monthly!

Why these three metrics?

Since I focus mostly on dividend growers, I want to see constant and often increasing dividend growth. Good and constant revenue and EPS growth are preconditions to a growing and sustainable dividend. The combination of these three metrics often leads to companies that have positive cash flow, repetitive and predictable income, a robust balance sheet, and a business model that has plenty of growth vectors.

A company with a strong dividend triangle also comes with another bunch of great metrics. As an investor, that’s the type of business you want; a thriving business able to go through a recession without too many worries and that’ll honor its promise to increase its dividend year after year.

Learn more about the dividend triangle here.

What does a weak dividend triangle mean?

Look at Equinix’s dividend triangle. It’s easy to understand a positive dividend triangle, right? Revenue keeps growing as does the earnings per share. The dividend growth is steady and even increasing.

Three line graphs highlighting the strong dividend triangle for Equinix: trends of revenue growth, EPS growth, and dividend growth — Equinix (EQIX): a strong dividend triangle

How do we explain a weak one? What do we do when a good company’s dividend triangle is weakening? What if one metric goes down? After a bad quarter or even a few bad quarters, don’t instinctively click the Sell button. Just like our energy level and our weight, numbers fluctuate, it’s normal.

It’s all about interpreting these deteriorating numbers to see what’s happening and whether things will get better soon. As I like to say, the trend is your friend. You must look at the triangle metrics over time, 5 years is a good duration, to see whether the poor results are a hiccup or part of a downward trend over a long time.

Along with the trend, it’s important to put the results in context, i.e., understand what is going on with the company, or around the company, that is making one metric, or the entire triangle go down, or up for that matter. Monitoring your stocks every quarter will help you to quickly spot trends and put results in context.

Get great stock ideas from our Rock Stars list, updated monthly!

When revenue is going down

Whether revenue is fluctuating down or up, you can often find the context for the change in the quarterly results press release or the investors’ presentation. They usually explain the factors that affected the revenue positively and negatively. Revenue could be down for a pretty good reason in which case you shouldn’t worry too much. Here are some examples:

Currency fluctuation. Take Coca-Cola; it makes many sales outside of the U.S. and generates a lot of revenue in other currencies. Revenue reported in U.S. currency is affected by the exchange rate. A U.S. dollar getting stronger will affect its revenue downward. To see if there was revenue growth or not, it’s important to also look at the numbers on a currency-neutral basis, which is stated in the press release.
Cycle of innovation or product cycle. Look at Apple’s dividend triangle below. There’s no frenzy around iPhones, nor is the company launching many products. As a result, over the last five or six quarters, sales and earnings haven’t grown as fast as they used to. This is normal if you look at Apple’s history. It goes through product innovation cycles and occasionally there’s a pause in growth before starting another upcycle.

Three line graphs showing Apple's dividend triangle. Sales and EPS at a plateau for the last 2 years as per its innovation cycle — Apple’s sales and EPS reaching a plateau due to the company’s innovation cycle

Industry-wide cycle. We can think about basic materials and the energy sector for example. If you look at the 2015-2020 period versus 2021-2026, when we get there, we’ll have a completely different picture of the energy sector; the whole sector goes through cycles.
Sometimes it’s just the economy. Recent reports from Home Depot, Canadian Tire, and railroad companies reveal there are slowdowns. We cannot expect huge revenue or earnings per share growth for 2024, and possibly 2025. This isn’t limited to a specific company, but entire cyclical industries getting hit by consumers spending less.

Putting the revenue slowdown in context helps you to differentiate between a temporary cause, such as a cycle fluctuation or a negative currency impact, or a permanent situation. By permanent situation, I mean things that are specific to the company and not resolved by time alone, if at all. This could be a company losing market share as it cannot adapt to increased competition (think Blackberry), or a business that isn’t relevant anymore because it’s in a dying industry and fails to innovate or diversify; remember printed media and video stores?

What about falling EPS and slowing dividend growth?

Yes, the triangle isn’t just about revenue. EPS and dividends are also key metrics that can show signs of weakness. We’ll explore that in next week’s article, along with a few other metrics.

In the meantime, it’s important to understand that you must look at more than one metric to assess the state of a company’s performance, good or bad. Also, remember that putting things in context is a must and the trend is your friend!

In the Spotlight: the Utilities Sector

Electricity, gas, and water are essential in our modern world. It’s hard to imagine a house without power or running water in North America. Companies in the utilities sector offer indispensable services to their customers, and they reward their shareholders with generous dividends.

Utilities include electric, gas, water, renewable energy, diversified, or independent power producer companies. They provide the public with necessities. Since we depend on electricity and water, utility companies hold a great deal of power over the population; it would be catastrophic to see our utility bill rising by 75% overnight!

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Regulating utilities

To mitigate the risk of utilities having too much power, some countries, provinces, or states nationalized these resources to provide them at a lower price. Often, in Canada and the U.S., governments allow private companies to manage and distribute electricity, gas, and water. Granting such power to private entities couldn’t be done without strict rules. Hence, utilities usually operate in a highly regulated environment. Governments decide the price of power and water that is charged to customers.

While this seemingly puts brakes on future growth, it does provide utilities with the benefit of a stable and predictable source of income over long periods. Consequently, don’t invest in utilities to make a quick buck. On the positive side, utilities tend to grow at a steady pace, not unlike the turtle winning the race against the rabbit.

Utilities sector strengths

Historically, utilities are regarded as generous with their dividends. They’re inclined to distribute over 50% of their available cash flow to their shareholders. The perfect type of business for dividend investors.

Utility companies need large infrastructures and most of their capital projects amount to billions of dollars. This limits the number of competitors who can enter the sector. In most cases, we describe the sector as a collection of natural monopolies. It doesn’t make sense for three electricity companies to spend billions on power generators and power lines to serve the same geographic area. Therefore, utility markets are normally well protected, and companies have nothing to fear but themselves. We had a great example of that with the poor management at Algonquin (more on that later).

If you’re looking to invest in renewable energy, know that those companies are in the utilities sector. Renewable energy companies aren’t getting much love in the market of late. While wind and solar energy are getting cheaper to generate and governments offer generous subsidies, most of the “energy money” went back to the oil & gas industry. This is probably an opportune time to buy undervalued renewable stocks in this crazy market!

Utilities sector weaknesses

Be mindful of the volume of debt these companies carry. You can bet any new utility project will cost at least several hundred million, or even a few billion dollars. Most often, those projects are financed by issuing additional shares of stock or taking on more long-term debt. When interest rates rise, the cost of new financing increases, reducing the projected profitability of the project. In short, there will be less cash left to increase the dividend.

Keep in mind that some projects fail. The Atlantic Pipeline, a joint venture project between Duke Energy (DUK) and Dominion (D), was canceled recently. Result? Billions in write-offs, Dominion even reduced its dividend because of the cancellation.

With high interest rates, capital-intensive utilities face another challenge. Some income-seeking investors left the boat and went back to their first love—bonds, GICs, and preferred shares. Fixed-income products pay a better interest rate and are more stable than renewable utilities! This explains part of the general stock decline since 2021. It could be a solid opportunity, however, if you’re a patient investor.

The demand for power follows the economy. During lockdowns in 2020, we saw industrial and commercial demand for power decline. In general, recessions also have an impact for a few years. To increase the rates they charge customers, regulated utilities must get approval from regulators. During challenging times, regulators might not agree to increase the rates, preferring to give consumers a break. A good example was Arizona regulators lowering the rate increase inquiry submitted by Pinnacle West Capital (PNW) in 2021.

Looking for growth and diversification in your portfolio? Explore the industrials sector.

The Algonquin story

When Algonquin reported its earnings in November 2022, management shared plenty of bad news: negative EPS revision, uncertainty around the financing for Kentucky Power acquisition, the impact of variable rates on their business model, etc. The result was catastrophic on the market. The stock dropped 35%, from $11.51 to $7.49, in 7 days.

Algonquin's decline depicted with graphs of its share price, revenue, EPS and dividend from 2018 to 2023. — Algonquin debacle starting in 2022-23

In a conference call with investors in early 2023, Algonquin announced a 40% dividend cut and more asset sales, worth another $1B. This call revealed a company that had lost its magic touch, and whose business model—aggressive growth by acquisition—had blown up in its face. Now, AQN wants to strengthen its balance sheet which was greatly affected by variable rate increases. When the tide went down, we all discovered that management was swimming naked in the ocean.

Getting the best of this sector

Utilities became the popular kids after the 2008 financial crisis. With bottom-low interest rates, income-seeking investors ignored bonds and certificates of deposit, turning to equities that provided better yields, like utilities. This has changed and could change more with the higher interest rates.

Also, the renewable energy industry has taken some serious hits. This could be the opportunity you were waiting for. Since utilities can’t expand their business in another state or province without an acquisition, keep track of which regions have the best economic growth opportunities.

At DSR, we prefer utilities using clean energy. They’re not too expensive right now and offer great potential for the next 10 years.

We also favor companies that have been around for a while, like Fortis which shows 50 consecutive years with a dividend increase. It has proven that it can reward shareholders even during challenging times.

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Should you invest in utilities?

The utilities sector is best suited for income-seeking investors. Income investors can invest between 10% and 20% of their portfolio in utilities without any worries. For growth investors, something between 5% and 10% should be enough.

My favorites are:

U.S.: NextEra Energy (NEE), Sempra (SRE), and Xcel (XEL).
Canada: Fortis (FTS.TO / FTS), Emera (EMA.TO), Brookfield Infrastructure (BIPC.TO / BIPC), Brookfield Renewable (BEPC.TO / BEPC).

Protect your Portfolio with Consumer Staples Stocks

Want to make your portfolio more resilient to economic downturns or worse, recessions? Look to consumer staples stocks. There’s a reason for consumer staples stocks to also be called consumer defensive stocks; they defend your portfolio from the assault of market crashes.

When we describe consumer staples, we often say they are all the products you can find in your house. Products you must buy no matter what happens in your life. Companies in this sector have built stellar brand portfolios that support repeat purchases from their customers. Repetitive purchases lead to constant and predictable cash flows. Therefore, food, beverage, and household products are a great foundation for building a dividend growth portfolio.

If you are concerned about the current state of the economy, add some consumer defensive stocks to your portfolio.

Also interested in growth stocks? Explore the Consumer Discretionary sector.

Consumer staples industries

The consumer staples sector includes companies in different industries:

Beverages – Brewers
Beverages – Non-Alcoholic
Beverages – Wineries & Distilleries
Confectioners
Discount Stores
Education & Training Services
Farm Products
Food Distribution
Grocery Stores
Household & Personal Products
Packaged Foods
Tobacco

Listen to our recent webinar “All-Time-High Markets: Should You Buy?” here.

Greatest strengths

If you’re looking for a place to stash your cash during tough times, forget about your mattress. Consumer staples stocks are defensive. When the market goes into panic mode, this part of the equity markets isn’t normally a source of worry. We saw how well grocery and discount stores performed during the pandemic in 2020. They were the first to be deemed “essential businesses” along with healthcare companies.

On top of selling “essential goods” (we could discuss how alcoholic and tobacco products are considered essential, but that’s for another time), this sector also shows another great characteristic. Most industries in this sector have built their business model around repetitive sales. What’s better for a dividend investor than to find a business that keeps selling the same products to the same consumers every week? This is what we call a cash cow.

Since consumers rely on many of these products, they’ll likely cut their expenses for consumer discretionary products, such as restaurant meals, non-essential clothing, travel, and entertainment, to prioritize consumer staples products. Keep in mind that while stocks in this sector offers great protection when the market goes sideways, you must have them before market sentiment shifts downward to benefit from their protection. When the market panics, consumer staples usually trade at higher valuations, i.e., their PE ratios increase.

Throughout the years, many consumer staple companies have built iconic brands. Some companies even manage portfolios of multibillion-dollar brands. Such large brands come with economies of scale and a wide distribution network, making it very difficult for potential competitors to enter the market. This also gives investors a sentiment of calm because they can count on them paying their dividends no matter what happens. Even when people lose their jobs, they’ll probably keep buying many of these brands!

Greatest weaknesses

Lack of growth is often a matter of concern for this sector. When emerging markets came into play, they all rode the wave and discovered new playgrounds.

As those markets grew many local competitors also came on the scene. While smaller players can’t compete on price and scale, they’re more flexible and know their customers better than those “gringos” coming from North America. Buy American and buy local are not just concepts that we have here in North America. It’s a movement trending around the world.

Speaking of competition, it now comes from everywhere in the staples sector. Beverage companies go after the snacks and packaged foods industries; discount stores that first introduced limited packaged foods are transforming into full grocery stores. Such competition first led to a shelf war where products were competing against each other for top space in stores. This has moved to the online world as online shopping has reached all industries. Margins are getting squeezed and inflation has done nothing to help those industries.

Those “old” staple companies must adapt to e-commerce. They face similar challenges to consumer discretionary companies when it comes to dealing with digital sales. Even groceries must invest massively in their online platform to let consumers order their food and pick it up at the store or have it delivered.

Listen to the replay of our recent”All-Time-High Markets: Should You Buy?” here.

How to get the best of consumer staple stocks

It’s hard to identify a good time to buy consumer staples stocks because they’re rarely “on sale”. When everybody is making money in the market and growth stocks get most of the love, you have a shot at buying lesser-loved consumer staples. This is the type of investment that you almost regret having made during a bullish year because they often lag, showing minimal growth during boom times. On the other hand, when panic spreads, these companies hold the fort and ensure your portfolio doesn’t go bust.

Most consumer staple industries are investments best suited to income investors. Not for their average yield, but rather for the stability they bring to one’s portfolio.

Income investors, you can get some of these “safe stocks” for up to 10% to 20% of your portfolio. You won’t generate a maximum of dividend payments from this sector, but you’ll reduce value volatility.

For growth investors, anything between 3% to 10% would work well. Too much money invested in this sector would impact your total return potential during a bull market.

Favorite Picks

Some of my favorite picks in this sector at the time of writing are the following:

Canada stocks: Alimentation Couche-Tard (ATD.TO), Jamieson Wellness (JWEL.TO), Premium Brands Holdings (PBH.TO), Metro (MRU.TO).
U.S. stocks: Costco (COST), Procter & Gamble (PG), Coca-Cola (KO), PepsiCo (PEP), McCormick & Company (MKC), Hershey (HSY).

Buy List Stock for March 2024: Capital Power Corp. (CPX.TO)

Our buy list stock for March 2024 is Capital Power Corp. (CPX.TO). This is an educated guess. The company is almost perfect, showing a strong business model and good metrics. However, it might come with price fluctuations because of the risks surrounding debt for such a capital-intensive business in the current landscape of high interest rates.

Want to see our U.S. buy list stock of the month? Click here.

Capital Power Business Model

Capital Power Corp. is a growth-oriented power producer company. It develops, acquires, owns, and runs renewable and thermal power generation facilities and manages its related electricity and natural gas portfolios. It runs electrical generation facilities in Canada and the United States. The Company has approximately 9,300 megawatts (MW) of power generation capacity at 32 facilities across North America.

Its projects under construction include over 140 MW of renewable generation capacity and 512 MW of incremental natural gas combined cycle capacity from the repowering of Genesee 1 and 2 in Alberta. It has over 350 MW of natural gas and battery energy storage systems in Ontario and approximately 70 MW of solar capacity in North Carolina in advanced development. Its La Paloma facility is in Kern County, California. The Company also has a natural gas generation facility in the Harquahala region of Arizona.

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CPX.TO Investment Thesis

Capital Power has invested heavily in new projects each year since 2012. This has enabled it to grow its AFFO consistently. Contrary to Algonquin Power (AQN), CPX currently shows funds from operation per share growth year after year despite higher interest rates.

After announcing the acquisition of Midland Cogeneration (a 1,633 MW natural gas combined-cycle cogen facility), it did it again in late 2023, acquiring a 50.15% interest in the 265 megawatts (MW) Frederickson 1 Generating Station in Pierce County, Washington. This will bring CPX’s revenue diversification to 50% U.S. and 50% Canada.

The acquisitions add another 1,608 MW of net capacity to CPX’s U.S. WECC portfolio, boosting run-rate U.S. EBITDA to ~40% of total contributions. Acquisitions are expected to bring an 8% AFFO growth per share. CPX is now the 5th largest natural gas IPP in North America.

We like CPX’s strategy of investing in renewable energy and its goal to abandon coal in 2024 and show zero net production by 2045, but profitability might be hard to achieve with these projects in this market. 22% of adjusted EBITDA was generated from renewable assets in 2021. An investor can expect continued profitability going forward as CPX keeps investing in renewables.

Graphs showing Capital Power Corp.'s stock price, revenue, EPS, and dividend payments over 10 years. Sollid growth — CPX.TO: accelerating revenue and earnings growth, steady dividend growth

CPX.TO Last Quarter and Recent Activities

In 2023, Capital Power continued to transform its Genesee generating station to move away from coal. It completed the work needed for Unit 3, now 100% natural gas-fuelled, and progressed the repowering of Units 1 and 2, with completion expected in 2024. CPX made its largest transaction ever with the acquisition of the La Paloma and Harquahala natural gas facilities, as well as the addition of the Frederickson 1 facility.

Capital Power reported a good quarter with revenue growth of 6% and funds from operation per share up 15%. AFFO increased due to lower overall sustaining capital expenditures resulting from fewer outage activities, and higher adjusted EBITDA.

Potential Risks for Capital Power Corp.

For several years, Capital Power’s had too much of its revenue coming from Alberta making it dependent on the state of the province’s economy. Through its multiple acquisitions, CPX brought its exposure to this province down to 31%.

As with all other utilities, CPX.TO is a capital-intensive business. It must invest heavily continually to generate more cash flow. The market might not be so eager to see additional debt to fund projects in the coming years. With higher interest rates, debt could become a burden. There’s no guarantee that liquidity will continue to be easy to get from capital markets. While CPX shows a healthier balance sheet than Algonquin, let’s not forget how aggressive growth by acquisition strategies can end when they’re not managed properly. Finally, weather variation could affect results as we’ve seen already, where warm winters reduce AFFO occasionally.

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CPX.TO Dividend Growth Perspective

Considering its various wind energy projects and the robust Alberta economy, CPX’s management expects to increase its dividend by 6% through 2025. Such a promise is always welcomed by income-seeking investors. Through its successful transformation into a diversified utility, CPX is earning its place among other robust Canadian utilities such as Fortis, Emera, and the Brookfield family.

Final Thoughts on Capital Power (CPX.TO)

CPX.TO intends to invest heavily in the wind energy business and to get many U.S. projects. Its diversification plan is paying off; it reduced Alberta’s contribution to its revenue to less than one-third and has managed to show sustained growth. The company now expects a dividend growth rate of 6% through 2025.

With its vigorous growth by acquisition strategy, Capital Power could face headwinds from high interest rates on significant debt. Investors aware of these potential risks and willing to live with them while the investment thesis stands might find it an attractive play.