NPIFF - Northland Power Stock: Why It's A Hold After Correcting 25%

Summary

• Northland Power stock has corrected 25% from its peak in 2022.
• The international renewable utility focuses on wind generation.
• Its trading history hints at lumpy growth after periods of consolidation.
• Investors are better to wait for its latest results this Friday before making a move.
• We currently rate it as a "hold" despite the stock appearing to be undervalued for the long term.

Northland Power ( OTCPK:NPIFF ) ( NPI:CA ) has declined about 25% from its peak in 2022 on the TSX. Could it be a buy-the-dip opportunity? It's hard to say. The one-year chart shows the stock is only down about 9% in the last 12 months.

(The company reports in Canadian dollars, so the figures in this article are in CAD$ unless otherwise noted.)

Why Did the Stock Correct?

We believe the main reason for the stock correction is that, like many other businesses, its cost of capital has increased. Particularly, the company already had high debt levels on its balance sheet, which would have been fine if interest rates stayed low. However, 2022 was a rising interest rate environment.

The renewable utility took action to improve its debt ratios and balance sheet over the last year, which generally makes it a safer business to invest in, but it also means slower growth in the near term.

The company last reported earnings -- its Q3 earnings results -- in November 2022. Its debt-to-asset ratio was 69% versus 77% at the end of 2021. Similarly, its debt-to-equity ratio was 2.37x versus 3.60x at the end of 2021. Its Q3 2022 interest expense declined 16% to $73 million versus Q4 2021.

Having high debt levels is a typical characteristic of utilities because they are capital-intensive businesses. Notably, Northland Power is given an investment grade S&P credit rating of BBB.

Growth

Northland Power has operations in 6 countries with a focus on wind power generation. The international renewable utility owns or has interests in 3GW of gross operating capacity.

Management is targeting growth from mature onshore wind markets like Germany and the Netherlands and emerging wind markets like Poland and Taiwan. It also has its sights set on onshore renewable markets (involving onshore wind, solar, and storage) such as New York, Alberta, Spain, and Colombia for high growth potential. Battery storage and hydrogen export are also other areas of growth.

The company sees the potential to quadruple its capacity to about 12GW by 2030 with the growth from identified growth projects (e.g. Alberta solar, German offshore wind, South Korean offshore wind projects, etc) as well as careful selection of additional investment projects from a pipeline of 20+ GW.

As you can see above, the pipeline consists of potential growth projects with 65% in wind and 25% in solar. Geographic diversification includes 40% in Europe, 30% in North America, and 25% in Asia.

Recent results

Northland Power last reported its Q3 2022 results. Specifically, in the first nine months of 2022, sales increased by 24% to $1.8 billion, gross profit rose 23% to $1.6 billion, while adjusted EBITDA (a cash flow proxy) rose 35% to $1 billion. It appears the company maybe efficiently run with good control of costs. Electricity production increased by 20%, which aligned with sales growth, but operating income climbed 60% to $822 million.

The company doesn't usually increase its dividend. As cost of capital has risen, it's even more unlikely for a dividend hike. That said, its dividend (a yield of ~3.6%) seems sustainable. Its free cash flow payout ratio was 58% based on dividends declared in the period.

Valuation

The stock's valuation has been compressed from increased cost of capital, including higher interest rates and a depressed stock price (that make equity offerings less attractive), leading to lower growth in the near term.

After reviewing its price to earnings and price to cash flow history, we thought its stock price followed the latter more closely, which is why we evaluate the stock valuation using the price-to-cash-flow fundamental analysis graph below. The stock's valuation based on price to cash flow suggests the stock trades at a slight discount of ~13%. Should growth resume longer term and the stock were to revert to a more normalized long-term multiple of about 7.7x, it'd be considered trading at a discount of ~23%, which is not far off from the analyst consensus discussed in the next paragraph.

Analysts believe the stock trades at a discount of 28% from the consensus 12-month price target of $46.63 per share, which also suggests near-term upside potential of 39%. Analysts generally think the stock is decently attractive, but who knows if the share price will actually appreciate or buy that much within such a short period.

Investor Takeaway

Some investors might like Northland Power for providing international exposure outside of North America. Others might find the business to be too complex (international operations, foreign exchange risk, etc.)

From the stock's long-term stock price history, investors would notice periods of consolidation followed by growth spurts -- in other words, lumpy growth.

The fact that management provided growth projections through 2030 is a hint that this renewable utility stock is a long-term investment that could provide satisfactory total returns from price appreciation and a safe yield of ~3.6%. The stock dip could also be a chance for investors to buy at a relatively low valuation versus the long-term normal average.

Technically, the stock is oversold on the daily chart, but it trades ~9% below its 50-day SMA, which is also trending downwards. It also trades under its 200-week SMA, as shown in the graph below.

Soon, the company will release its Q4 and full-year 2022 operating and earnings results after the market closes on February 23. Depending if it reports positive/negative news for its Q4 and 2022 results or 2023 outlook, the stock will react accordingly on Friday.

Cautious investors are better to wait for its latest results this Friday before making a move. Therefore, we incline to rate the stock a "hold" today. However, long-term investors who are bullish on renewables, particularly in wind, and plan to invest capital for the long term (perhaps through 2030) might consider nibbling a small/partial position here.

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