Best Canadian Stocks

High-Risk High-Reward Stock for June 2024: Allied Properties REIT (AP.UN.TO)

On my buy list since April 2023, Allied Properties REIT (AP.UN.TO) has moved to the top on that list for Canadian stock paying a yield of 4% or more. Allied Properties is still not getting a lot of love from the market due to the negative sentiment around the real estate sector, and even worse for office properties. We continue to believe that AP is a very interesting play. Its stock price decline makes it a good entry point for investors interested in a speculative real estate stock. This is a falling knife—high risk, high reward—so proceed with caution.

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Allied Properties Business Model

Allied Properties is a Canada-based open-end real estate investment trust (REIT). It owns and operates unique urban workspaces in Canada’s cities and network-dense urban data centers in Toronto.

It provides knowledge-based organizations with distinctive urban environments for creativity and connectivity. Allied Properties operates in seven urban markets in Canada: Montreal, Ottawa, Toronto, Kitchener, Calgary, Edmonton, and Vancouver.

Allied engages in third-party property management business, providing services for properties, in which a trustee of Allied Properties has an ownership interest.

AP.UN.TO Investment Thesis

Allied features one of the strongest balance sheets among Canadian REITs. It has much of its capital invested in low-cost projects and is currently paying down higher-interest debt while simultaneously investing in new projects.

AP.UN.TO maintains its unique expertise in managing and developing prime heritage locations, which will continue to be in high demand in the coming years. The REIT also counts on many technology clients, which represent a growing sector in Canada.

There are still concerns surrounding office REITs, but Allied Properties has proven its resilience in difficult times. The 2023 distribution increase (+2.7% in early 2023) and low payout ratio for a REIT were good signs.

AP remains a high-risk, high-reward play; investors must do their due diligence and monitor the occupancy rate and FFO per unit growth.

AP.UN.TO Last Quarter and Recent Activities

Allied Properties did well in its most recent quarter, all things considered, with revenue up 4%, and Adjusted Funds from Operations (AFFO) per unit up 1%. The AFFO payout ratio for the quarter stands at 83.8%. Same Asset NOI (net operating income) from Allied Properties’ rental portfolio was down 2% while Same Asset NOI from its total portfolio was up 2.9%, reflecting the productivity of its upgrade and development portfolio.

AP.UN.TO’s occupied and leased area at the end of the quarter was 85.9% and 87%, respectively. This was lower than the previous quarter. We wish we would see this number go above 90%. Allied Properties remains a speculative play. Below is Allied Properties’ dividend triangle showing the falling stock price but revenue going back up. As always with REITs, look to FFO or AFFO per unit rather than EPS.

Potential Risks for AP.UN.TO

Most of Allied Properties’ income is derived from office properties. We know how the pandemic left a dent in the real estate market, especially for office space. Some workers were eager to return to the office, while others weren’t willing to. Many enjoy working from home and the way we work may be forever changed. There will be demand for quality office buildings, but how we will use offices in the coming years remains uncertain, and parking revenues might be weaker going forward.

AP.UN.TO’s properties are mostly located in Ontario (Toronto) and Quebec (Montreal). This limited geographic diversification can leave it vulnerable to economic changes in these provinces. We saw in their latest quarterly update that both regions had been affected. Fortunately, smaller markets such as Calgary and Vancouver showed strong occupancy rates. The global occupancy rate is at 87% for Q1 2024. We advise to not to enter a position unless you are willing to take the risk.

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Allied Properties Dividend Growth Perspective

When evaluating a REIT, we look for dividend increases that at least match inflation. This is the case with AP.UN.TO. The company has a 2.5% dividend CAGR over the past 5 years and healthy FFO and AFFO growth. An investor can therefore expect 2-3% annual dividend growth going forward.

For the full year 2022, AP.UN.TO’s AFFO payout ratio was 81%. It increased its distribution by 2.7% in 2023 (after a 3% increase in 2022), for an annual distribution payment of $1.80/share. After paying its special distribution in December 2023, AP.UN.TO hasn’t increased its distribution increase yet in 2024 but still shows a healthy AFFO payout ratio of 80%. If AP.UN.TO’s distribution doesn’t increase by the end of 2024, it will lose its dividend safety score of 3 at Dividend Stocks Rock . Allied Properties pays a monthly distribution.

Final Thoughts on Allied Properties REIT

With still much uncertainty around office space use in the future and Applies Properties’ occupancy rate on a downtrend (87% in Q1 2024 vs. 87.3% in Q4 2023 vs 89.5% in 2022), this is a speculative play.

However, AP.UN.TO still has decent payout FFO and AFFO payout ratios (77.8% and 83.8% respectively), making its guidance sustainable. It boasts unique heritage properties in urban areas and clients in the growing technology sector. It also has a strategic objective to establish its urban rental-residential portfolio.

With its stock price at under $17, compared to $21 a year ago and $32 two years ago, and distribution increases matching inflation (though not yet in 2024), this falling knife could be an interesting real estate play. Again, potential high reward, but high risk!

CNR and CNQ – Beat the Competition on Cost

CNR and CNQ are two companies that hold cost advantages over their competition. Canadian National Railway (CNR.TO) is a transportation and logistics company while Canadian Natural Resources (CNQ.TO) is in oil & gas exploration and production.

They have a cost advantage because they can produce goods or services at a cheaper price than their competitors. A cost advantage can be used in two ways:

1) Crush the competition with low price

Often, the easiest way to gain market share is to sell at a cheaper price than their competitors. When they produce the same goods or services at a lower cost, they can undercut competition. This is what Canadian National Railway (CNR.TO) does.

2) Sell at the same price, but make a lot more profit

When the business model permits, some companies will sell at the same price as their competitors. Their advantage is in the higher margin they enjoy thanks to their lower operations cost. They then become money-making machines. Canadian Natural Resources (CNQ.TO) often does this.

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Canadian National Railway – Offering lower prices

Railroads are known to be one of, if not the cheapest way to transport goods across land. With Canada and the U.S. amongst the largest countries in the world, CNR (and Canadian Pacific Kansas City CP.TO for that matter) are quite popular. Railroads are less flexible than truck transport, but they are surely the lowest-cost transport.

But CNR is more than railway transport! Its services also include intermodal, trucking, and supply chain services. CNR’s rail services offer equipment, customs brokerage services, transloading and distribution, private car storage, and more. Intermodal container services help shippers expand their door-to-door market reach with ~23 strategically placed intermodal terminals. These services include temperature-controlled cargo, port partnerships, logistics parks, moving grain in containers, custom brokerage, transloading and distribution, and others. Trucking services include door-to-door service, import and export dray, interline services, and specialized services.

CNR.TO dividend triangle as of May 2024 — CNR.TO dividend triangle: trend of stock price, revenue, earnings per share, and dividends over 10 years

Known as “best-in-class” for operating ratios for years, CNR boasts strong operational performance, with velocity and speed staying solid metrics quarter after quarter. CNR has tirelessly improved its margins and was among the first railroad companies to do so. Today, its peers have caught up and are managed in the same way.

CNR profits from cost advantages over trucking and other transportation methods, and from the scale of its operations which is virtually impossible to replicate. These advantages give it what is called a wide economic moat, meaning that it will enjoy these benefits for 20 years or more. Therefore, it can count on increasing cash flows each year.

The good thing about CNR is that investors can always wait for a down cycle in the economy to invest in it. You can bank on it going back on a roll when things pick up and consumers and businesses buy more goods.

Canadian Natural Resources – Raking in the profits

A play in the energy sector is Canadian Natural Resources, an oil and gas exploration and production company. CNQ enjoys long-life assets with low declines in its reserves. The company can produce oil and natural gas at an extremely low cost. This enables CNQ to ramp up production when prices are up and boost their margins. During down cycles, it can slow down production and still be highly profitable. In other words, its cost advantage makes CNQ a cash flow-making machine.

Canadian Natural Resources (CNQ.TO) dividend triangle: revenu, EPS, and dividend growth over 10 years — CNQ.TO dividend triangle: trend of stock price, revenue, earnings per share, and dividends over 10 years

CNQ sits on a large asset of non-exploited oilsands and its break-even price for the WTI grade of crude is $35. However, the fact that oilsands are not exactly environmentally friendly and that more and more countries look to produce greener energy and electric cars does cool our enthusiasm a bit.

Despite this, CNQ is very well positioned to surf any oil boom. It invested heavily, and it is now generating higher free cash flow because of that capital spending. CNQ appears at the top of my list for a long-term play in the oil & gas industry. I also appreciate CNQ’s shareholder-friendly approach, as it will return 100% of free cash flow to shareholders after hitting $10B in net debt.

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Cost-advantaged companies in other industries

There are companies in other industries that also enjoy cost advantages over the competition. Think of Costco which positions itself as the largest customer of its suppliers to gain negotiating power and offer the lowest prices to its customers.

Walmart is another great example of a cost-advantaged business. As a dominant retailer and among the largest grocers in the U.S., WMT built its entire business model around offering “low prices every day”. Walmart “squeezes” every penny from its suppliers to 1) offer the cheapest price possible to customers and 2) crush most competitors. You don’t go to Walmart for its exceptional customer service, but rather to pay as low a price as possible for everyday goods.

The cost advantage can be deadly. Amazon founder, Jeff Bezos, once said “Your margin is my opportunity”. Companies, such as Barnes & Noble, thought they were doing well, and that no competition could kill them. Along came Amazon with a different business model focused on building a strong cost advantage. Barnes & Noble survived, barely, but it’s not a flourishing business anymore.

Spotlight on Brookfield Asset Management (BAM.TO / BAM)

We aim to spotlight Brookfield Asset Management, the new kid in the Brookfield family of companies. In 2022, Brookfield separated its asset-light management business as BAM and renamed the parent company, which was called Brookfield Asset Management, to Brookfield Corporation (BN). Confused? You’re not alone. So, BAM is an asset-light alternative asset manager…what the heck is that and is it a worthy investment?

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Alternative assets and asset-light management

Alternative assets are non-traditional investment opportunities different from conventional asset classes like stocks, bonds, and cash. Examples include real estate, private equity, infrastructure, venture capital, commodities, etc. Such assets are not as liquid as conventional assets and require expert management. They can also take longer to generate returns; for example, it can take several years for venture capital invested in a new startup or capital put into new complex infrastructure projects to create high returns. They demand patience from investors.

An asset-light management business like BAM doesn’t have many physical assets. It develops strategies, manages, and leverages funds from institutional investors, such as pension plans, retail clients, and other investors. It invests these funds into varied assets, which can include physical assets like those operated by other Brookfield companies, such as Brookfield Renewables and Brookfield Infrastructure. BAM makes most of its money from fees charged on its total assets under management (AUM).

Learn about another Brookfield company, Brookfield Infrastructure.

About Brookfield Asset Management

BAM offers three product categories: long-term private funds, perpetual strategies, and liquid strategies. It operates through Brookfield Asset Management itself and its subsidiaries.

Brookfield Corporation (BN.TO / BN), the parent company of the Brookfield family, owns 75% of BAM.

Spinning off the asset-light management business into BAM enabled Brookfield to create a capital-light company with zero debt and lots of cash and financial assets to support growth. To be clear though, Brookfield’s debt didn’t disappear, but rather wasn’t transferred to the asset management business (BAM).

BAM investing narrative

BAM makes money by charging fees on AUM. Therefore, the more money it raises for investments, the more its earnings grow. Since supply and demand influence AUM, you can expect BAM to show cyclical growth as the market fluctuates.

Even though alternative assets require more time to produce returns on the market than equities, investors tend to be nervous during bear markets; this affects alternative asset managers. We saw how a bad market in 2022 combined with higher interest rates increased nervousness and impacted all asset managers, alternative or not.

BAM will likely grow its AUM at double-digit growth rates for many years. The urgent need to invest in infrastructure and renewable energy will attract lots of money to the largest alternative asset managers. BAM is among the largest ones with approximately $929B of assets under management (up 11.4% from a year ago). If BAM can increase its AUM during a bad market like what we’ve seen since 2022 (+15% between 2022 and 2023, and +11.4% from 2023 to 2024), imagine what will happen when the market goes back into bull mode!

Below is the evolution of BAM’s stock price since the spin off in late 2022, and of its revenue, EPS, and dividend. Eighteen months isn’t a trend yet, but BAM’s off to a good start.

As most of BAM’s clients are pension plans, sovereign funds, insurance companies, and the like (e.g., big guys with big wallets and a long-time horizon), BAM’s portfolio will generate a constant income stream. Since most of its earnings come from fees charged on the AUM (as opposed to performance fees on how well they do), BAM has built a sticky business.

Recently for BAM

In early May, Brookfield Asset Management reported a good Q1 2024. It showed strong growth of 15% in its fee revenue from its flagship, private credit, and insurance strategies over the past year, on the back of over 15% growth in related fee-bearing capital over the same period. BAM saw lower transaction fees and lower fees associated with its permanent capital vehicles. BAM raised $20B of capital during the quarter, compared with $37B in Q4 2023.

Potential Risks for Brookfield Asset Management

BAM’s growth depends on investors’ confidence in long-term projects. When panic arises, it becomes difficult for companies like BAM to increase their AUM.

Brookfield invests for a time horizon of decades, while investors tend to be hungry for short-term news. This distortion often translates into short-term fluctuations and stock price drops. Well-managed, BAM has the expertise to navigate crises. Investors must simply be patient. The Brookfield family of companies is complex, which makes some investors wonder how money is managed within the business, including in BAM.

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BAM.TO / BAM Dividend Growth Perspective

The management team in place has an enviable reputation for generating growth for investors. This is also true when it comes to dividend payments. BAM earns base management fees from private funds, which are mostly contracted and predictable. As an asset-light alternative manager, BAM distributes more of its earnings to shareholders than its parent company, Brookfield Corporation (BN).

Following the spin-off, BAM’s initial dividend of $0.32USD/share paid quarterly increased to $0.38USD/share, a generous 19% hike!

Lastly

The new BAM is a pure play on alternative asset management. Interest in alternative assets is increasing, especially for institutional investors. It’s still early days, with only 18 months of results since becoming a pure asset-light manager. However, backed by the Brookfield family of companies and enjoying a lot of expertise, this large asset manager might be a very good play for patient investors. Also, with a dividend yield of 3.8, it fits well in many investors’ portfolios.

Buy List Stock for May 2024: Telus (T.TO / TU)

A buy list stock of mine since March 2023, Telus is still in my top five Canadian picks for growth. As future growth in the wireless industry is limited, Telus has diversified its business to find new growth vectors. The company is acting wisely in the face of the current headwinds by reducing its capital expenditures (CAPEX) and increasing its cash from operations. It hasn’t received a lot of love from the market in the last two years, and likely won’t in 2024, but I believe that will change eventually; in the meantime, investors enjoy consistent mid-single-digit dividend increases every year.

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Telus Business Model

TELUS Corporation is a Canada-based telecommunications company. The Company provides a wide range of technology solutions, including mobile and fixed voice and data telecommunications services and products, healthcare software and technology solutions, and digitally led customer experiences.

Data services include internet protocol, television, hosting, managed information technology and cloud-based services, software, data management and data analytics-driven smart-food chain technologies, and home and business security. It operates through two segments.

The technology solutions segment includes network revenues and equipment sales arising from mobile technologies, data revenues, some healthcare software and technology solutions, voice, and other telecommunications services revenues.
The International segment is comprised of digital customer experience and digital-enablement transformation solutions, including artificial intelligence (AI) and content management solutions.

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Telus Investment Thesis

Telus has grown its revenues, earnings, and dividend payouts very consistently. Very strong in the wireless industry, the company is now tackling other growth vectors such as internet and television services. Telus has the best customer service in the wireless industry as shown by its low customer loss rate. It uses its core business to cross-sell its wireline services. The company is particularly strong in Western Canada. Telus is well-positioned to surf the 5G technology tailwind.

Finally, Telus looks to original and profitable ways to diversify its business. Telus Health, Telus Agriculture, and Telus International (tech & games, finance, eCommerce, and artificial intelligence) (TIXT.TO) are small, but emerging divisions that should lead to more growth going forward. In 2022, Telus acquired Lifeworks for $2.3B to boost its health business segment.

In 2023, CAPEX slowed down ($2.6B) and was mostly financed by free cash flow ($2B). This explains why the company keeps its generous dividend growth streak alive. For 2024, the company expects lower CAPEX and stronger operating cash flow. We like that mix!

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Telus Last Quarter and Recent Activities

Starting in 2023, the macroeconomic landscape has made it a challenging time for the telecommunications industry and Telus is no exception—years of fueling growth through cheap debt ended with rising interest rates.

Telus recently reported lackluster results for Q1’24. Consolidated revenue was down 0.6% and adjusted EPS was down 3.7% compared to Q1’23. Revenue for wireless/wireline revenue was up 0.4%, but down in for Telus Health (-0.7%), Agriculture (-0.24%), and International (-.98%).

Cash flow from operations of $950M increased 25% from Q1’23, but free cash flow was down 26% to $396M, due in part to interest charges going up to $394M from $320M.

Telus is keeping its CAPEX stable, a wise move during this difficult time. It reaffirmed its 2024 full-year guidance that it will have sufficient cash flow to pay dividends.

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Potential Risks for Telus

Competition is increasing among the Big 3 in the wireless market; Rogers and Shaw merged, and a new player is arriving on the scene, with Quebecor acquiring Freedom Mobile. Margins could be under pressure in the future. Also, the federal government wants more competition for the “Big 3” and is likely to open the door to new competitors down the road.

As the wireless market becomes fully mature, Telus will need other growth vectors. TV & internet won’t be enough to prevent Telus from becoming another Verizon (VZ) ten years from now. We’re not convinced by the acquisition of Lifeworks, specifically its cost. We will see how Telus integrates the business into its Health division.

Finally, Telus’ debt has increased substantially, from $12B in 2015 to $27B in 2024. Higher rates might affect future profitability, especially if they persist. Everyone expects tate cuts in 2024, but so far, the Bank of Canada keeps delaying them due to inflation. The headwinds facing the company explain its stock performance as of late.

Telus Dividend Growth Perspective

This Canadian Aristocrat is by far the industry’s best dividend payer. Telus has a high cash payout ratio as it puts more cash into investments and capital expenditures. Capital expenditures are regularly taking away significant amounts of cash due to their massive investment in broadband infrastructure and network enhancement.

Such investments are crucial in this business, and, for a good while, Telus filled the cash flow gap with financing. At the same time, Telus continued to increase its dividend twice a year, exhibiting strong confidence from management. In 2023, Telus increased its dividend twice for a total increase of 7% for the year.

However, with the higher cost of debt and other macroeconomic challenges, Telus has wisely reduced its capital expenditures. This decision has already helped increase its operating cash flow, contributing to the dividend’s safety. Investors can still expect the dividend to increase, but I suspect the dividend growth will slow down in 2025 while the company faces the current headwinds and because of its lower free cash flow.

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Final Thoughts on this Buy List Stock

The story for Telus in 2024 is about three important metrics: cash from operations, capital expenditure (CAPEX), and free cash flow. I want to see the first one go up, the second one go down, and the last one to cover the dividend payments. I have Telus in my portfolio. Over the next few quarters, I will keep an eye on these metrics.

Right now, Telus is struggling a bit and not performing as well as I’d like. I still see a lot of potential in its diversified business areas, Telus Health, Telus Agriculture, and Telus International. These should eventually generate growth for the company. For a patient investor who’s in it for the long haul, Telus could be a great opportunity and that’s why it’s a buy list stock of mine.

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.

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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.

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.

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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.