2023-09-26 11:30:45 ET
Summary
- Shares of Atlantica Sustainable Infrastructure have declined by 31.5% over the past year, resulting in a near-all-time high dividend yield of 8.6%.
- However, Atlantica's operations are resilient, with a diverse asset portfolio and long-term power purchase agreements providing stable cash flows.
- Combining a shareholding in Atlantica with selling covered calls could allow investors to realize strong annualized income returns.
Shares of Atlantica Sustainable Infrastructure (AY) have declined by about 31.5% over the past year, resulting in the stock's yield climbing to a near-all-time high of 8.6%.
While this in itself is likely to classify Atlantica as a compelling pick amongst income-oriented investors, the current sentiment in Atlantica's options offers the opportunity for shareholders to boost their income meaningfully.
Specifically, I believe that combining a shareholding in Atlantica with selling covered calls should allow investors to realize an annualized income yield close to 15%, all while improving their margin of safety.
In this article, I will:
- Provide a concise overview of Atlantica's operations and its current asset portfolio.
- Delve into the factors exerting downward pressure on Atlantica's share prices.
- Examine the resilience of Atlantica's operations in the face of prevailing challenges.
- Analyze Atlantica's attractive 8.6% dividend yield and explore strategies for harnessing it alongside covered call options to generate substantial income while managing risk effectively.
Let's go!
Atlantica's Operations: A Brief Review
Atlantica's core operational strategy revolves around the ownership and proficient management of an extensive renewable energy portfolio.
Based on its most recent quarterly filings , Atlantica's portfolio contains 44 renewable energy projects , collectively boasting a capacity to generate 2,161 megawatts of clean energy. Within this expansive portfolio, 31 projects are dedicated to solar and wind farms, while seven focus on the crucial domains of transmission and transportation. Additionally, three projects are committed to optimizing natural gas utilization, with another three revolving around water-related initiatives.
What truly sets Atlantica apart is not just the breadth of its asset base across a spectrum of project types but also its extensive global footprint. While a substantial portion of its revenue stream, approximately 40% , stems from North America, the company's cash flows are far from sourced by a singular region. Europe and South America contribute 34% and 18%, respectively, to its cash flow mix, while the remaining 8% is dispersed across the globe, with significant contributions from countries such as South Africa and Algeria.
The company primarily serves a customer base comprised of either private or government-owned electrical utilities, typically engaging in long-term Purchase Power Agreements (PPAs). Moreover, Atlantica also leverages long-term concession contracts, resulting in its assets currently enjoying an average remaining contract term of approximately 14 years.
Finally, 92% of Atlantica's interest rates in project debt are fixed or hedged - a major advantage during a rising-rates environment.
What's Keeping Atlantica Stock Under Pressure?
Having declined by roughly 31.5% over the past, shares of Atlantica have underperformed the overall market significantly during this period. But what is actually keeping Atlantica's stock under pressure?
The answer can be broken down into two primary factors:
- A shifting market sentiment due to rising interest rates,
- and Algonquin Power & Utilities (AQN) - AY's biggest shareholder potentially offloading its shares
Shifting Market Sentiment Due To Rising Rates
The first factor contributing to the decline in Atlantica's stock price can be attributed to a shift in investor sentiment. In simple terms, the stock's cost of equity has increased significantly following the shift to a rather shaky macro landscape.
For context, in 2021, during the excitement running through equities induced by the pandemic, investors were drawn to Atlantica for its yield. However, as interest rates began to climb, investors started offloading their holdings in Atlantica. They did this in response to the heightened risk associated with equities and the necessity for a higher return from a yieldco.
Particularly, in 2021, Atlantica's dividend had declined to as low as 3.59%. Given the gradual increase in the Federal Funds Rate, which currently stands between 5.25% and 5.50%, it is understandable that investors have been gradually demanding a higher yield from Atlantica.
Atlantica's Yield (Seeking Alpha)
This demand stems from their need to be adequately compensated for the added risk associated with holding this stock. This explains the gradual decline in the stock's value during the ongoing period of interest rate hikes and why the market has now pushed the stock's yield up to 8.6%.
Algonquin Power & Utilities Potentially Offloading Its AY Shares
The second factor contributing to the decline in Atlantica's stock price can be attributed to growing speculation over Algonquin Power & Utilities selling their equity state in the company. The Canadian company is Atlantica's major owner, holding about 42% of its shares.
In Ju ly, activist hedge fund Starboard Value encouraged AQN to sell its equity stake in Atlantica to r educe debt and improve earnings. This comes after AQN amassed significant debt ( currently at $8.15 billion ) following completing a series of acquisitions in previous years. With rates on the rise, it's no wonder AQN needs to deleverage its overburdened balance sheet.
As a result of this, Atlantica stock has been under additional pressure.
Nevertheless, Atlantica's Operations Remain Resilient
Despite the backdrop of increasing interest rates and the added pressure stemming from AQN's potential equity stake divestiture, Atlantica's operational resilience remains steadfast.
As previously highlighted, Atlantica possesses a diverse asset portfolio, consistently delivering robust results through its enduring power purchase agreements (PPAs). These agreements, supported by esteemed off-takers, offer exceptional cash flow transparency and risk mitigation.
With an impressive average remaining contract tenure of approximately 14 years, Atlantica's future revenue stream stands firmly secure, allowing the management to chart a strategic course for future investments and dividend growth. Yet, the advantages extend further. Around half of the portfolio is linked to inflation-based indices or predetermined hikes over time.
Consequently, Atlantica's assets have continued to perform well despite the inflationary challenges witnessed over the past year. But how resilient are these PPA anyway? Well, to truly appreciate the resilience of Atlantica's long-term PPAs, it is essential to underscore the exceptional creditworthiness of the company's off-takers.
Atlantica's off-takers, predominantly government-affiliated entities such as The Government of Peru and The Kingdom of Spain, or industry giants like Enel Generacion Chile ( ENIC ), significantly reduce the risk of default on their contractual obligations. But besides their creditworthiness, it must be noted that Atlantica's projects comprise mission-critical infrastructure with regards to these clients meeting their electricity generation goals.
Finally, despite Atlantica's substantial international footprint and reliance on foreign off-takers, a remarkable 90% of the company's contracted revenues are either denominated in USD or diligently hedged to the dollar. This prudent approach provides an added layer of safeguarding. This is because it ensures the stability of the company's cash flows in the face of currency fluctuations and other foreign exchange-related risks.
Decent H1 Earnings Demonstrate Business Qualities
The qualities I've just described are mirrored in the company's H1-2022 performance , which demonstrates notable strength. During this period, Atlantica achieved an impressive adjusted EBITDA of $403.8 million, marking a 1.9% increase when compared to the first half of 2022.
Furthermore, Atlantica recorded a growth of 2.6% in its cash available for distribution (CAFD) compared to H1-2022, totaling $124.6 million. On a per-share basis, CAFD grew by 0.3% to reach $1.07.
The slight difference between the overall CAFD and the per-share metric can be attributed to a larger share count. In turn, this can be attributed to share issuances to fund investments and acquisitions over the past year. Regardless, the resilience of CAFD in the current market climate is truly commendable.
How to Generate An Income Yield of ~15% through Covered Calls
When investors are buying Atlantica, it's usually due to the company's reliable dividend. Atlantica's dividend is currently yielding 8.6%. For starters, I believe that Atlantica's dividend remains well-covered. Let's examine:
In March, management released their outlook, which has been consistent, and anticipates CAFD ranging between $235 million and $260 million for fiscal 2023. Assuming the company achieves the midpoint of this range and minimally impacts shareholders, I anticipate CAFD per share for the year to settle at approximately $2.08, a figure in line with the previous year's performance.
If the upper end of this range is attained, it's plausible that CAFD per share will be even higher. However, let's exercise caution. Therefore, despite the possibility of increased rates, Atlantica's current annualized dividend per share rate of $1.78 should remain adequately secured.
Now, let's examine Atlantica's options book.
In this example, I suppose someone writes May 17, 2024, covered calls. Still, you can boost your income by choosing shorter-term options as well. Since the point here is to enjoy both Atlantica's hefty yield and generate extra income via the premium, choosing the furthest away dates makes sense, in my view.
AY options book (Seeking Alpha)
As you can see, you can generate around $0.85/share with a strike at $22.50. The annualized yield from this option, assuming it expires worthless, can be found by first annualizing the premium (divide by 8, multiply by 12) and then dividing again by the current stock price of $20.64.
Therefore, $0.85/8*12/$20.64 = 0.0618, or 6.18%. Along with the annualized dividend yield of 8.6%, investors can generate an annualized income yield that approaches 15% (14.8% based on these numbers). Yes, "annualizing" the premium doesn't really make sense. It's just a way for me to provide some perspective.
So, let's look at three different realistic scenarios:
- Scenario 1: Shares trade above the strike price of $22.50 at maturity:
That's actually a great outcome! You have generated both a great income and sold the stock at a profit! You will have generated an annualized return of:
$1.74/$22.64=7.7% ($1.64 being the premium + two $0.445 dividends) or 11.5% on an annualized basis +
($22.50-$20.64)/$20.64*100 = 9% annualized return from the stock price, or 13.5% on an annualized basis.
Thus, the annualized returns could reach close to 25%.
- Scenario 2 : Shares trade flat (i.e., stable share price):
In this scenario, you retain just the $0.85 premium and receive two $0.445 dividends. Thus, our total return is $1.74/$22.64= 7.7% or 11.5% on an annualized basis.
- Scenario 3: Shares move to $20.90 or lower:
At any price below this level, you start losing money. Your breakeven price should be equal to $20.90 (current price of $22.64 - premium+dividends of $1.74). However, this also reflects the additional margin of safety you can get by selling covered calls on Atlantica stock.
Takeaway
Overall, Atlantica Sustainable Infrastructure presents an intriguing opportunity for income-oriented investors following the recent decline in its share price. Its noteworthy 8.6% dividend yield, combined with the strategic use of covered call options, offers the potential for investors to realize a substantial income yield.
In the meantime, the company's core operations should remain robust, backed by numerous qualities. This should be a favorable catalyst for Atlantica's stock to stabilize. Therefore, one of the two favorable scenarios materializing (i.e., a stable or higher share price) seems probable. In that case, you can likely enjoy strong annualized return prospects. In any case, covered calls can effectively reduce the risk of holding Atlantica individually.
For further details see:
Atlantica Sustainable: Combine Its 8.6% Yield With Covered Calls For A ~15% Annualized Income Yield