CPXWF - Capital Power: A 6.1% Yield With A 35% AFFO Payout Ratio

2023-08-03 11:30:00 ET

Summary

• Capital Power is a sizeable power producer with a strong position in Canada's Alberta province.
• The company is now guiding for a full-year AFFO of north of C$7/share, meanwhile the stock is trading at just C$40.
• The dividend was hiked by 6% and the company confirmed its plans to continue to increase it by 6% per year.
• This will result in a 7% yield by the end of 2025, at a payout ratio of less than 50%.

Introduction

As mentioned in a previous article , Capital Power ( CPX:CA ) ( CPXWF ) is an Alberta, Canada based independent power producer undergoing a major change as one of its main facilities is being converted to burn natural gas rather than coal. The company has low sustaining capex requirements and is able to spend the majority of its AFFO on dividends (with a targeted payout ratio of 45-55%, and it looks like this year's payout ratio will come in below 40%) and growth projects (mainly in the solar and wind space). The company has just released its H1 results and confirmed a dividend hike .

Very strong power prices lead to an excellent result

As Capital Power is a power producer, it does have to deal with sudden swings and volatility in the power price. While a portion of the production has been hedged, the exposure to spot power rates could result to either a good quarter or a weak quarter.

In the second quarter of this year, Capital Power got lucky. The spot price increased to C$160 per MWh in the second quarter of this year, which is an increase of in excess of 25% compared to the second quarter of last year. That's great because it allowed Capital Power to boost its net realized price. About 85% of the output was hedged but the 15% exposure to spot prices ensured an average realized price of around C$85 per MWh which was better than initially expected. Unfortunately, the power production was slightly lower due to some (planned and unplanned) outages. A more important contributor to the excellent result in Q2 was the contribution from Midland Cogen which was only acquired in the second half of last year. This means the revenue from joint ventures increased from C$10M in Q2 2022 to C$82M in Q2 of this year. As a reminder, Midland Cogen was acquired for approximately C$1.3B and Capital Power expected the transaction to add about C$0.38 in AFFO on an annual basis.

The total revenue in the second quarter was approximately C$823M resulting in a gross margin of C$387M due to the higher operating expenses. The operating income decreased by about C$10M and the bottom line shows a net income of C$85M and a net income of C$87M attributable to the shareholders of Capital Power. This represents an EPS of C$0.68 after also taking the preferred dividend payments into consideration.

That's not necessarily bad, and it's safe to say the higher income from the joint ventures saved the day while it is also encouraging to see Capital Powers' finance expenses haven't ballooned yet.

Of course, the income statement is heavily impacted by the depreciation and amortization expenses which represented almost 40% of the gross margin. That's why it's at least equally and perhaps even more important to keep an eye on the AFFO calculation which only takes the sustaining capex into account. As you can see below, the total AFFO during the second quarter was C$151M which works out to C$1.29 per share.

And the H1 result was even stronger as the total amount of sustaining capex increased on a QoQ basis, with an AFFO of C$3.09/share.

Capital Power's dividend continues to increase

This means the company is generating plenty of cash to continue to increase the dividend. As explained in my previous article, Capital Power promised the market a 6% dividend CAGR in the 2023-2025 time frame. While I didn't expect the company to increase its dividend by 6%, that's exactly what Capital Power did. The quarterly dividend will be hiked to C$0.615/share (for an annualized dividend of C$2.46/share). This also means the mid-term dividend growth rate remains intact and applying the same 6% CAGR should result in a dividend of C$2.76 in 2025.

Not only would this represent a dividend yield of almost 7%, making Capital Power attractive from an income perspective, it also is fully backed by the anticipated incoming AFFO. Capital Power is still working on the Genesee conversion (see my previous articles) and although there are some delays, the converted power plant should be online in 2024.

And just to be clear, the company's full-year AFFO will be higher than what we saw in the first half of the year. As you can see below, Capital Power has confirmed its full-year guidance with a C$805-865M AFFO and it now expects its full-year result to exceed the mid-point of that guidance. If I would still use the midpoint of the guidance of C$835M, the AFFO/share will come in at C$7.13.

Investment thesis

Capital Power is currently trading at an AFFO multiple of less than 6 for an AFFO yield of just under 18% based on the current share price. While power prices will obviously continue to fluctuate, Capital Power is in an excellent financial shape. Despite the 6% dividend increase, the company will retain about C$500M in AFFO which it can use to fund additional acquisitions and growth investments.

I currently have no position in Capital Power but I will likely initiate a long position soon. I'm mainly interested in the dividend but, depending on the company's guidance for 2024, I think the potential to realize capital gains is quite realistic as well.

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