Atco Ltd (TSX: ACO.X) is a Canadian holding company that offers gas, electric, and infrastructure solutions. The largest subsidiary of the company is Canadian utilities, which operates natural gas, electricity, and logistical services. Atco's primary segments include electricity (generation, transmission, and distribution), pipelines and liquid, Neltume Ports and Structures and logistics. Headquartered in Calgary, Alberta, the firm mainly operates in Canada and Australia, along with some operations in the United States, the United Kingdom, and Mexico.

Organizational Structure

Source: Company Presentation

Revenue Mix

Business Segment                             Geographic Segment                                                                                           

Investment Rationale:

• Insiders are Buying ATCO Shares: Over the past six months, insiders stand as the net buyer for ATCO shares. At the same time, insiders have increased their stake for 13 times, which implies that the insiders are bullish on the future performance of the company. Increased insider buying amid a challenging operating environment provides a lot of confidence to the retail investors.

Insiders Activity. Source: Refinitiv (Thomson Reuters)

• Significantly Higher Free Cash Flow Yield: The company is offering a higher free cash flow yield of 15.2%, whereas the industry average free cash flow yield stood at 4.8%. The higher free cash flow yield shows solid cash generation ability of the company and a competitive advantage against the peers. Further, a higher free cash flow yield provides a lot of confidence in the company's balance sheet and reflects the strength of the company. Also, higher free cash flow assures that the investors will continue to receive the consistent dividend as the company is generating consistent free cash flow. Further, on September 30, 2020, the company's cash position stood at CAD 1,298 million, an increase of CAD 158 million compared to December 31, 2019. 

• An Income Play: Atco's shares are offering a lucrative dividend yield of 4.5%, which is approximately 34% higher than the TSX Composite Index dividend yield of 3.35%. Moreover, the company has increased the common share dividend each year since 1993, a 27-year track record of increasing dividend. Dividends paid to Class I and Class II Shareowners totaled CAD 50 million in the third quarter and CAD 150 million in the first nine months of 2020. On October 8, 2020, the Board of Directors declared a fourth-quarter dividend of 43.52 cents per share.

Source: Company Presentation

• Investment Grade Credit Profile: Credit ratings are important to the company's financing costs and ability to raise funds. The Company intends to maintain strong investment grade credit ratings in order to get efficient and cost-effective access to funds required for operations and growth. On September 17, 2020, S&P Global Ratings affirmed its 'A-' long-term issuer credit ratings on ATCO Ltd. S&P Global Ratings affirmed ATCO’s subsidiary CU Inc's 'A-' long term issuer credit rating and maintained a stable outlook. On August 28, 2020, Dominion Bond Rating Service affirmed its 'A (low)' long-term corporate credit rating and stable outlook on ATCO. On August 10, 2020, Dominion Bond Rating Service affirmed its 'A' long-term corporate credit rating and stable outlook on ATCO subsidiary Canadian Utilities.

Source: Company Presentation

• Risk Associated to Investment: The Company's operations are exposed to a variety of business and financial risks. The risks include a decline in customer demand, increase in operating costs, interruption of project work, the credit risk associated with customer non-payment, access to financing and change in the timing of cash flows.

3QFY20 Financial Highlights

Source: Company Filing

Key Highlights:

• Revenues for the third quarter of 2020 were CAD 897 million, CAD 200 million lower than the same period in 2019. Lower revenues were mainly due to forgone revenue following Canadian Utilities' sale of the Canadian fossil fuel-based electricity generation business in the third quarter of 2019 and subsequent sale of Alberta PowerLine (APL) in the fourth quarter of 2019.
• Lower revenues were also due to the completion of manufacturing of ATCO Structures' LNG Canada Cedar Valley Lodge contract in the second quarter of 2020, and the timing of settlements related to regulatory decisions in the Alberta Utilities. Lower revenues were partially offset by growth in Canadian Utilities' regulated rate base.
• Adjusted earnings for the third quarter of 2020 were CAD 54 million or CAD 0.47 per share, compared to CAD 74 million or CAD 0.65 per share for the same period in 2019. Lower adjusted earnings in the third quarter of 2020 were mainly due to Canadian Utilities' sale of the Canadian fossil fuel-based electricity generation business and 80 per cent ownership interest in Alberta PowerLine in 2019, which together contributed CAD 19 million in adjusted earnings in the third quarter of 2019.
• Earnings attributable to Class I and Class II Shares were CAD 54 million in the third quarter of 2020, CAD 106 million lower compared to the third quarter of 2019. Earnings attributable to Class I and Class II Shares include timing adjustments related to rate-regulated activities, unrealized gains or losses on mark-to-market forward and swap commodity contracts, one-time gains and losses, significant impairments, and items that are not in the normal course of business or a result of day-to-day operations.

Business Segment

STRUCTURES & LOGISTICS   

Adjusted Earnings. Source: Company Presentation 

• Lower adjusted earnings were mainly due to scheduled completion of ATCO Frontec North American contracts, partially offset by additional client work requests at existing contract sites for COVID-19 proactive and preventative safety measures.

NELTUME PORTS

Adjusted Earnings. Source: Company Presentation

• Adjusted earnings in the third quarter of 2020 were at par with the same period in 2019.
• There have been lower cargo volumes at some terminals due to the impact of the COVID-19 pandemic on trading activity in the regional geographies where Neltume Ports operates. This impact was partially offset by a stronger performance at unaffected terminals elsewhere in the portfolio.

CANADIAN UTILITIES

 Adjusted Earnings: Source: Company Presentation

• Lower adjusted earnings were mainly due to sale of the Canadian fossil fuel-based electricity generation business and Alberta PowerLine in 2019, which together contributed CAD 19 million in adjusted earnings.
• Excluding the forgone earnings impact from the sale of these businesses, adjusted earnings in the quarter were CAD 3 million higher than the same period in 2019. Higher earnings were mainly due to improved earnings in the non-regulated businesses.
• Announced the acquisition of the Pioneer Pipeline for CAD 255 million. The 131-km natural gas pipeline west of Edmonton, Alberta facilitates the conversion of the Sundance and Keephills coal-fired electricity generating plants to cleaner-burning natural gas.
• Received regulatory decision on the 2021 Generic Cost of Capital proceeding. The Alberta Utilities Commission approved the extension of the current return on equity of 8.5% and equity thickness ratio of 37% on a final basis for 2021.

Top-10 Shareholders

Top-10 shareholders held approximately 50% stake in the company with Sentgraf Enterprises Ltd and RBC Global Asset Management Inc. are among the top owners with an outstanding position of 25.7% and 7.14% respectively. Also, six out of top-10 shareholders have increased their stake in the company. Institutional ownership in the company stood at 31.56%, and strategic ownership in the company stood at 26.34%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): Price to Earnings based Valuation Metrics

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters)

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation:  The company’s business model is defensive in nature with a diversified customer base and 79% investment grade customer net exposure. Also, Not rated and below investment grade customers comprise 3,400 businesses that are diversified by industry, geography, and customer type, as well as retail customers.

The company has solid financial strength, with a cash position of approximately CAD 1,298 million, an increase of CAD 158 million compared to December 31, 2019. Further, its shares are offering a lucrative dividend yield of 4.5% amid falling interest rate environment, which would bring its shares in the limelight, especially for income-seeking investors. Also, the group has a track record of consistent dividend payment and dividend growth over the past 27-years.

Further, an increased insider buying over the past 6-months shows that despite the current challenging business condition, the insiders are quite bullish on the future performance of the company.

Therefore, based on the above rationale and valuation done, we have given a “Buy” recommendation at the closing price of CAD 38.77 on December 04, 2020.

Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at December 7, 2020 price as well.

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