NPIFF - Northland Power Stock: Why We Just Bought Some

2023-05-15 10:26:40 ET

Summary

• Northland Power stock has corrected 24% in the last 12 months.
• A 12% drop occurred after it reported its Q1 earnings results. We provide potential reasons.
• At a lower stock price, the stock now offers a dividend yield of 4.1%.
• We think the stock finally warrants another look by higher risk investors as a potential buy for a trade.

We last covered Northland Power ( NPIFF ) ( NPI:CA ) in February here . At the time, we thought Northland Power didn't have a big enough margin of safety to warrant the purchase of new shares. The utility stock fell a whopping 12% on the TSX after reporting its Q1 earnings.

The one-year chart shows the stock is down close to 24% in the last 12 months. Is it finally a good buy-the-dip opportunity? We believe so - at least for a starter position. Let's dig a bit deeper.

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

Q1 Results

Northland Power just reported its Q1 2023 results on May 9. Specifically, sales fell 11% to $621.7 million, gross profit declined 11% to $568.9 million, while adjusted EBITDA (a cash flow proxy) dropped 16% to $351.7 million.

Electricity production fell 3%, and its operating income shrank 25% to $272.5 million. Operating cash flow declined by a third to $297.1 million, leading to free cash flow ("FCF") of $154.7 million (down 11% year over year).

Higher interest rates have led to higher cost of capital for new or refinanced debt and making it less attractive (maybe even irrational) to issue equity offerings.

The company doesn't usually increase its dividend. As the cost of capital has risen, it's even more unlikely for a dividend hike. That said, its dividend (a yield of ~4.1%) seems sustainable. Based on the dividends declared in the period, its payout ratio was 49%. Based on the dividends paid, though, the payout ratio of 32% had a better margin of safety.

Why Did the Stock Correct Another 12%?

What may be in its Q1 results that led to a 12% decline in the stock?

In the press release, the company pointed out that year to date as at May 9, the company issued $42 million worth of common stock at an average price of $34.43 per share. We don't think that was the bad news because it's a modest issue of about 1.2 million shares (or ~0.5% of its shares outstanding), although no issuance would have been even better.

Perhaps the correction had partly to do with the Baltic Power Offshore Wind Project as it expects to come to a financial close this year, but management anticipates an increase in the project cost that's higher than the previously estimated range of $5 to $6 billion because of inflationary pressures.

Another reason that weighs on Northland Power is its high debt levels, even in relation to some of its dividend-paying peers. Specifically, its debt-to-asset ratio was 65% versus 66% at the end of 2022. Similarly, its debt-to-equity ratio was 1.89x versus 1.98x at the end of 2022. Its Q1 2023 interest expense declined 18% to $67 million versus Q1 2022. That said, it still earns an investment grade S&P credit rating of BBB.

2023 Guidance

Notably, management believes the utility is "on track to achieve (its) full year financial guidance", which is a part of its Q1 press release title. The outlook is as follows:

• Adjusted EBITDA of $1.2 to $1.3 billion (based on the midpoint, this would be a decline of 11% versus the levels in 2022),

• Adjusted FCF per share of $1.70 to $1.90 (a decline of 8%), and

• FCF per share of $1.30 to $1.50 (a decline of 13%).

Valuation

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 ~18%. 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 ~29%, which is not far off from the analyst consensus discussed in the next paragraph.

Analysts believe the stock trades at a discount of 31% from the consensus 12-month price target of $42.52 per share, which also suggests a near-term upside potential of 45%. Analysts generally think the stock is decently attractive, but it could certainly take longer, perhaps a few years, to arrive at the $40+ level.

Investor Takeaway

Northland Power has a track record of developing renewable projects with a focus on (offshore and onshore) wind power generation. Because it provides a better margin of safety from a valuation perspective as well as from the perspective of offering a higher dividend yield of ~4.1% (thanks to the stock price decline) with a dividend that we believe is sustainable, we rate Northland Power as a "cautious buy".

We think, if appropriately sized in a diversified portfolio, Northland Power could work as a satellite/trading position that pays a decent dividend. The idea is to buy it at a sufficiently large margin of safety, collect the monthly dividend, and aim to sell at a price closer to its fair value with the main goal of price appreciation.

A recession is expected in Canada and the United States this year. If the central banks reduce the benchmark interest rates as a result (potentially in 2024/25), valuation expansion could occur for Northland Power, potentially pushing the stock up to $40+ levels in a few years' time.

Interested investors should consider buying Northland Power on the TSX instead of on the OTC market, where it's thinly traded.

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