2023-06-20 03:40:46 ET
Summary
- AltaGas preferred shares offer a strong risk-reward at their current yields, with the series B providing a tax-advantaged yield of over 11% tied to floating rates.
- The company's stable US utility operations provide significant value and protection to the dividend through stable earnings.
- I have changed my exposure to the B shares from the A shares, as floating rates seem more likely to rise than fall.
AltaGas ( OTCPK:ATGFF ) ( ALA:CA ) is a Canadian midstream and power company that expanded its presence in the US with its 2018 purchase of WGL Holdings, which was primarily a gas utility in the Washington, D.C. area. The company has been a long-time issuer of Canadian preferred shares, but in the last few years they redeemed a number of the higher yield issues and replaced them with subordinated note financing. That debt is non-publicly traded, and doesn't qualify for the dividend tax credit for Canadian investors. This piece will be an update from my previous piece covering AltaGas preferred shares. My own position within the complex has changed, and interest rates have moved up dramatically since then, so an update seemed warranted.
AltaGas Business
The firm has two primary lines of business - they own natural gas midstream assets primarily in Alberta, Canada and surrounding areas (hence the portmanteau name "AltaGas") and utility assets in the United States. Prior to the pandemic they had made a large purchase of the natural gas utility in the Washington, D.C. area, and the business is now ~60% US utility assets and 40% Canadian midstream assets. They previously owned an Alaska natural gas utility, which they recently sold at an excellent multiple with the proceeds used for deleveraging, which strengthens their credit metrics going forward.
Preferred Shares
This piece will focus on the investment merits of their preferred shares. There are a number of issues, which are summarized in the table below, all with a $25 face value. They are all reset preferred shares, which means that the payments will vary based on an underlying interest rate. The AltaGas issues reset based on Canadian Government rates, either the five year rate or the 30 day Canadian T-Bill rate. All of the issues have a $25 face value, and all are redeemable at the option of the company every five years. All figures in the below table and throughout the article are in CAD.
Distribution | Ticker | Current Yield | Spread | Reset Benchmark | Price | Yield After Reset | Reset Date | US Symbol |
0.765 | ALA.PR.A | 5.23% | 266 | Government of Canada 5-year | $14.63 | 10.76% | Sep 30, 2025 | ATGPF |
1.88 | ALA.PR.B | 11.20% | 266 | Government of Canada 3 month | $16.78 | 11.21% | Sep 30, 2025 | |
1.34825 | ALA.PR.E | 6.58% | 317 | Government of Canada 5-year | $20.50 | 8.30% | Dec 31, 2023 | AGEEF |
1.0605 | ALA.PR.G | 6.06% | 306 | Government of Canada 5-year | $17.50 | 9.57% | Sep 30, 2024 | ATGAF |
1.98 | ALA.PR.H | 10.18% | 306 | Government of Canada 3 month | $19.45 | 10.19% | Sep 30, 2024 |
Source: Author's Database, AltaGas Filings
In my previous piece, I had disclosed a position in ALA.PR.A ( ALA.PRA:CA ), with the logic being that it had the highest yield after reset of the issues, and that because it had the lowest spread (and the lowest price) it had the most upside leverage from increases in interest rates. Since rates were very low at the time I viewed increases as more likely than decreases, and that is very much what happened. I was correct that it would outperform the issues with minimum resets, because as interest rates rose the high-spread issues were called at $25 for smaller gains than what the As earned, and the As did outperform the higher spread Gs.
They did not however, outperform the floating rate issues or the E's, and I think the reason is the same for both. The Es are anticipating the reset to current five year rates at the end of the year, while the As don't reset until the end of 2025. With the yield curve inverted, the market seems to be suggesting that rates will drop by then. That same yield curve inversion is also very good for the floating rate B's and H's, which have appreciated more quickly as they immediately get the benefit of higher rates.
Given the inversion and the higher current and future yields available on the floating rate issues, I've swapped my position from the five-year-reset A's to the floating rate B's. That part is basically an interest rate call - since all the securities have the same issuer and seniority, the differences in return come down to their different terms. And floating rates are higher than five year rates right now, and based on Bank of Canada discussion I think they will continue to raise them for at least a little while.
Which Floating Rate Preferred to Pick
Both ALA.PR.B ( ALA.PRB:CA ) and ALA.PR.H ( ALA.PRH:CA ) adjust their payment every quarter with the changes in short-term rates. The only difference between the two is the spread, with Hs paying 3.06% above the benchmark rate and the B's paying a less spread of 2.66%. Naturally the Bs trade at a lower price, which more than compensates for the lower payments at current interest rates. In fact, the Bs are so much cheaper that at any positive underlying Canadian 30-day rate the Bs will have a better yield on cost than the Hs at their current relative pricing. The only time the Hs would come out ahead would be if interest rates went negative, which doesn't seem like a big risk to me at present.
While most online resources show the trailing yield for these preferred shares (which is wrong going forward because rates have risen) you can confirm their current dividend payments and get a link to the prospectus showing the formula directly on the AltaGas preferred share page .
AltaGas Credit Discussion
Of course, it doesn't matter which series of AltaGas preferred share we pick if the underlying issuer stops making the dividend payments, so a discussion of the credit quality of the underlying business is necessary. DBRS, which is generally the standard agency for Canadian preferred shares, has them rated as PFD-3H, where the H stands for high. Broadly speaking, the ratings for Canadian prefs mostly vary from PFD-2H at the top end for large stable financial firms to PFD-3L at the bottom end for highly levered entities. The parent company holds an investment grade credit rating from S&P and Fitch on the debt side as well. However, I prefer to evaluate the creditworthiness myself both qualitatively and quantitatively.
On the quantitative side, they had $7.97 billion of debt outstanding as of their last financial statements , as well as $600 MM of outstanding preferred shares. That compares to the firm reporting normalized EBITDA of $1.537 billion, so they are levered 5.6X through the preferred shares. They have been undertaking initiatives to de-lever, including the aforementioned sale of the Alaskan utility, and their stated strategy is to de-lever to 5X debt-to-EBITDA in the medium term and 4.5X debt-to-EBITDA in the long term. If they complete those goals it would be beneficial for the credit quality of the preferred, but even at 5.6X I think their leverage is appropriate given the qualitative factors.
Specifically, their business is very durable and stable. The US utilities are approximately 60% of the business and they are regulated rate utilities with reasonable regulated returns on investment. The midstream segment participates in the natural gas value chain throughout Western Canada, and has significant take-or-pay contracts on a large portion of its assets, and where it doesn't they are generally advantaged. As an example, their export capacity for propane and butane are the closest large scale terminals to Asia for those products. I think this business deserves to exist and it will continue to earn reasonable returns on its capital which will be sufficient to continue to make its payments.
The other qualitative factor I think is relevant is their continued access to low cost financing. Last month they sold senior unsecured notes with a three year term and a 4.638% coupon. The Government of Canada benchmark 3 yield rate on May 11th (when that deal closed) was 3.5%, so they paid only slightly over a 1% premium to the sovereign for that money. That suggests to me that the market has a limited amount of concern about their ability to repay it, which I find helpfully confirming of the thesis here.
Taxes
AltaGas is a Canadian corporation, and the dividends are eligible for the dividend tax credit for Canadian investors. That improves the after-tax value of the dividends when the shares are held in non-registered accounts. For US investors, there is Canadian withholding tax of 15% (as result of the Canada-US tax treaty). Shares held in US retirement accounts (e.g. IRA) are exempt from the withholding tax by that same treaty. For US investors outside of retirement accounts, the tax will be withheld, but there may be an opportunity to reclaim it as a tax credit.
Conclusion
I think AltaGas preferred shares are a strong risk-reward at their present yields. Investors in the series B (ALA.PR.B) are receiving a tax-advantaged yield in excess of 11% tied to floating rates that seem more likely to rise than fall. The stable US utility operations are a source of significant value and provide protection to the dividend in the form of stable earnings. I have changed my exposure to the B shares from the A shares.
For further details see:
AltaGas Preferred Shares: Strong Yield And Good Credit Quality