AltaGas Ltd (TSX: ALA) operates an energy infrastructure business with two business segments including, Utilities and Midstream. The regulated utilities segment delivers natural gas to homes and businesses. The segment, which accounted for 75% of the company’s revenues in the first quarter, serves about 1.7 million customers. The company, through ownership of regulated natural gas distribution utilities and two regulated natural gas storage utilities, has a rate base of nearly US$ 4.1 billion. The company’s utilities business also has storage facilities and contracts for interstate natural gas transportation and storage services. Moreover, through the affiliated retail energy marketing business, AltaGas serves about 0.5 million customers. The company’s midstream business comprises of global export assets and strategically located processing, fractionation, and liquids handling infrastructure in Canada. The company has a 70% interest in the Ridley Island Propane Export Terminal (RIPET) and indirect interest in Ferndale and Petrogas Terminal.

• Resilient, diversified business: AltaGas remains uniquely positioned to benefit from its resilient and diversified business model irrespective of the economic cycles. The company’s high-quality energy infrastructure assets in the utilities segment are backed by long-term commercial agreements, which ensure stable cash flows. Meanwhile, its high-growth assets in the midstream segment continue to drive solid growth as evident from the company’s first quarter performance. Despite difficult operating environment amid COVID-19 outbreak, AltaGas reaffirmed its 2020 normalized EBITDA guidance of CAD 1.275 – CAD 1.325 billion. Moreover, the company continues to expect normalized EPS of CAD 1.20 – CAD 1.30 in 2020. AltaGas’ outlook reflects continued growth in the utilities business led by investments in the ageing infrastructure, cost reduction, and rate base and customer growth. Meanwhile, increased utilization of RIPET and higher volumes in the midstream segment are likely to support the 2020 EBITDA.

EBITDA by Segments (Source: Company Reports)

• Utilities segment ensures stability: AltaGas generates most of its revenues and EBITDA from the utilities segment, where earnings remain largely insulated. Notably, management expects about 60% of the normalized EBITDA in 2020 to come from the utilities business, which remains highly stable. Investors should note that the utilities segment’s ~70% of the revenues are protected through fixed distribution charges and decoupled rate structures. Moreover, the management expects low sensitivity on the unprotected revenues as the majority of revenues are derived from residential customers. Going forward, we expect the utilities segment’s revenues and profits to benefit from the rate base growth and higher returns through rate case settlements. Also, increased utilization of accelerated replacement programs and cost reduction programs are likely to drive the segment’s profitability. AltaGas expects the utilities rate base to increase by 8% - 10% annually in the coming years.

Utilities Rate Base Growth (Source: Company Reports)

• Strong midstream business: AltaGas’ midstream segment continues to benefit from its strong export capabilities and access to premium-priced markets that enable it to attract more production. Further, the segment’s diversified customer base mitigates counter-party risk. Despite the challenging operating environment, AltaGas’ 2020 midstream earnings are backed by the fee for service agreements and long-term take or pay contracts. Also, the company’s comprehensive hedging program mitigates commodity risks and positions it well amid turbulent times. Notably, at RIPET, about 80% of its expected 2020 volumes are hedged at an average FEI to Mont Belvieu spread of approximately US$ 10.50/Bbl. Moreover, about 93% of the frac-exposed NGL volumes are hedged for 2020. Investors should note that the RIPET was completed in the second quarter of 2019 with the first shipment of propane to Asia on May 23, 2019. RIPET provides a strong underpinning for growth and is likely to be the key catalysts for growth thanks to the increase in utilization rate and export volumes. Investors should note that RIPET is garnering strong interests from producers, which is expected to drive volumes higher. The management expects volume ramping up to 50,000 bbl/d by the year end. Meanwhile, RIPET has secured 50,000 Bbl/d of supply as of April 1, 2020. Meanwhile, about 33% of its total expected volumes are under long-term tolling agreements. Propane demand growth in Asia, and demand/supply imbalance is likely to support the company’s energy export business. Moreover, in the processing business, projects coming online in 2020 are expected to add significant volume growth supported by growth in take-or-pay commitments.

• Dividend play: AltaGas stock currently offers a dividend yield of 5.9%, which is attractive. We believe the company’s diversified and low-risk business model with predictable cash flows make AltaGas a perfect income stock. The company’s stable utilities business, high growth midstream business, and cost reduction measures are likely to support its cash flows, in turn, its dividend pay-out. Investors should note that about 80% of 2020E normalized EBITDA is likely to come from the regulated utilities business and investment grade counterparties. Rate base growth and higher volumes at RIPET are likely to boost growth in the coming quarters.

Q12020 Financial Highlights: AltaGas reported healthy first quarter results on April 30. The company’s revenues came at CAD 1,869 million, down about 2% from the prior year quarter as warmer weather remained a drag in the utilities segment. However, midstream revenues showed solid growth and supported the top line. The company’s operating and administrative expenses increased to CAD 338 million from CAD 350 million. The y-o-y decrease reflects the impact of the sale of its U.S. distributed generation assets. AltaGas posted normalized EBITDA of CAD 499 million, up about 4% from CAD 482 million in the prior year quarter. Meanwhile, management stated that its core businesses normalized EBITDA jumped more than 11% driven primarily by the utilities business.

Depreciation and amortization expenses came in at CAD 105 million in the first quarter, as compared to CAD 118 million in the first quarter of the prior year. Interest expenses came in at CAD 70 million, down from CAD 93 million in the prior year quarter. The decline in interest expenses reflects lower debt balance.

Normalized net income came in at CAD 220 million or CAD 0.79 per share, up from CAD 214 million or CAD 0.78 per share in the prior year quarter. The increase in normalized net income reflects benefits from the utilities business, lower depreciation and amortization costs and decline in interest expenses. However, higher income tax expenses remained a drag.

Normalized funds from operations stood at CAD 420 million, up from CAD 376 million in the prior year quarter. As of March 31, 2020, net debt was CAD 7.0 billion, as compared to CAD 7.2 billion at December 31, 2019. Total debt stood at CAD 7,364 billion. Net debt-to-total capitalization ratio stood at 45% as of March 31, 2020, lower than 49% as of December 31, 2019. At the end of the first quarter, AltaGas had cash & cash equivalents of CAD 335 million, which was significantly above the CAD 57 million reported at the end of December 2019.  

Q12020 Financial Highlights (Source: Company Reports)

Top 10 Shareholders:

The top 10 shareholders have been highlighted in the table, which together forms around 27.46% of the total shareholding. QV Investors Inc. is the entity holding maximum shares in the company at 9.84%. RBC Global Asset Management Inc. is the second-largest shareholder, with a holding of 5.66%.

Top Ten Shareholders (Source: Thomson Reuters)

Key Metrics:    

In FY19, the company had an EBITDA margin of 10.0%, which is significantly higher than the 4.0% reported in the prior year. AltaGas’ net margin also marked stellar improvement in 2019 as compared to 2018.

Key Metrics (Source: Thomson Reuters)  

Key Valuation Metrics:

Key Valuation Metrics (Source: Thomson Reuters)

Valuation Methodology (Illustrative): EV/EBITDA Multiple Approach

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock recommendation: AltaGas stock is down about 18% so far this year, which presents a good opportunity for the long-term. The company’s business remains immune to economic cycles and generates predictable cash flows. AltaGas’ management expects growth to sustain in both the business segments in 2020 despite the COVID-19 outbreak. The company’s utilities business is likely to benefit from strong rate base growth. Meanwhile, higher returns through rate case settlements and increased utilization of accelerated replacement programs bode well for growth. AltaGas’ midstream business is expected to gain from the increase in utilization and full year of contributions from RIPET. Meanwhile, an increase in volumes at the northeast B.C. facilities are expected to support growth. Higher revenues and cost reduction strategies are expected to drive cash flows, in turn, its dividends. Notably, AltaGas stock currently offers a lucrative dividend yield of 5.9%, and we expect the pay-out to sustain in the coming quarters on the back of the regulated revenues. We have valued the stock using EV/EBITDA based relative valuation methodology and considered peers like Canadian Utilities Ltd (TSX: CU), Algonquin Power & Utilities Corp (TSX: AQN) etc. We arrived at a target price with an upside potential of lower double-digit (in percentage terms). Hence, we have given a “Buy” recommendation  on AltaGas stock at its closing price of CAD 16.19 per share on May 1, 2020.

 ALA One-Year Daily Price Chart (Source: Thomson Reuters)

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