Company Profile

Atco Ltd (TSX: ACO.X) is a Canada-based multiline utility company, which offers infrastructure solutions to customers around the world. The Company is engaged in the business activities: Structures & Logistics, Canadian Utilities and Neltume Ports. The Structures & Logistics business unit's activities are conducted through two businesses: Modular Structures and Frontec.

Organizational Structure

Source: Company Presentation

Revenue Mix

Business Segment                                                 Geographic Segment

                                                                      

Investment Rationale

Hefty Free Cash Flow Yield: The group’s free cash flow yield stood at 13.2%, which reflects the group’s ability to generate solid cash flow. Also, higher free cash flow yield provides a margin of safety to the existing and potential shareholders. This also reflects that regardless of economic conditions, the group is well-positioned in terms financial strength to pass through the challenging times.

Solid Fundamentals: Over the last five years, the company has consistently delivered an EBITDA margin above 35%, operating margin above 20% and a net margin above 10% (except in 2015). The above performance reflects that the company has a track record of the solid fundamentals. The group has also outperformed the sector in terms of EBIDTA margin, Operating Margin, Net Margin and Return on Equity.

Institutional Investors’ are increasing the stake: Institutional ownership in the company stood at 32.19%, and strategic ownership in the company stood at 32.19%. Six out of top-10 shareholders have increased their stake in the company, while only two have reduced the stake.

An Income Play: The group has a solid history of dividend payment, and the group has consistently increased its dividend distribution since 1993. At the last traded price, the group’s shares were offering a dividend yield of 4.4%, which is lucrative considering the current interest rate environment prevailing in the economy. The current yield is approximately 22% higher than the TSX Composite Index dividend yield of 3.6%.

Source: Company Presentation

Investment Grade Credit Profile: The group has been assigned investment-grade credit rating with a stable outlook by the credit rating agencies. Investment-grade credit rating is imperative to the company’s financing costs as it helps in accessing the capital markets at a very competitive rate. Also, despite a relatively higher Debt/Equity ratio of 2.36x, an investment-grade credit rating increases the confidence in the balance sheet.

Source: Company Presentation

Strong Liquidity: The company is maintaining a strong financial position and solid liquidity. At the end of the second quarter of FY20, the group's cash position stood at CAD 1.14 billion, which implies that the group's market cap is just four times its cash position.

Source: Company Presentation

Risk Associated to Investment: The Company's earnings from its foreign operations are exposed to fluctuations in exchange rates. The company is also exposed to transactional foreign exchange risk through transactions denominated in a foreign currency. Regulated Utilities are subject to the normal risks faced by regulated companies. These risks include the regulator's approval of customer rates that permit a reasonable opportunity to recover service costs on a timely basis, including a fair return on rate base.

2QFY20 Financial Highlights

Source: Company Filings

Key Highlights:

• The group’s revenue declined to CAD 938 million. Lower revenue in the second quarter was mainly because of forgone revenue following the sale of Canadian fossil fuel-based electricity generation business in Q2FY19 and subsequent sale of Alberta power Line in Q4FY20.
• During the quarter, the group’s adjusted earnings declined to CAD 70 million. The decline was on account of the sale of Canadian fossil fuel-based electricity generation business and 80 per cent ownership interest in Alberta PowerLine in 2019, which together contributed CAD 9 million in adjusted earnings in the second quarter of 2019. Lower earnings were also due to CAD 7 million in the prior period adjusted earnings from an Electricity Transmission regulatory decision received in the second quarter of 2019.

Business Segment

STRUCTURES & LOGISTICS - Adjusted Earnings

Source: Company Presentation 

• The segment’s adjusted earnings increased to CAD 21 million from CAD 7 million recorded in the previous corresponding period. The increase was mainly due to higher workforce housing trade sale activity in Canada, the US and Australia, continued progress with the LNG Canada Cedar Valley Lodge contract, and higher space rental activity in Canada, the US and Australia.
• The group is awarded a 30-month workforce lodging services contract in BC for approximately 600 persons to support the construction of the Trans Mountain Expansion Project.
• The group is awarded a design, supply and installation contract for two modular hospital facilities in Mexico City and Tijuana to support the fight against COVID-19.

 

NELTUME PORTS - Adjusted Earnings.

Source: Company Presentation

• Lower adjusted earnings in the second quarter of 2020 were mainly due to unplanned equipment maintenance activity at Puerto Mejillones in northern Chile and overall lower cargo volumes related to the COVID-19 pandemic.
• While all of Neltume Ports' terminals remained operational, there have been lower cargo volumes in 2020 compared to 2019 mainly due to the impact of COVID-19 pandemic on trading activity in the regional geographies where Neltume Ports operate.

CANADIAN UTILITIES - Adjusted Earnings

Source: Company Presentation

• Lower adjusted earnings in the second quarter of 2020 were mainly due to the sale of Alberta PowerLine and the Canadian fossil fuel-based electricity generation business in 2019, which together contributed CAD 9 million in adjusted earnings in the second quarter of 2019. Lower earnings were also due to the Electricity Transmission regulatory decision received in the second quarter of 2019, which included CAD 7 million in adjusted earnings that were related to prior periods.
• On June 22, 2020, LUMA Energy, LLC, a newly-formed company owned 50% by Canadian Utilities and 50% by Quanta Services, announced that it has been selected by the Puerto Rico Public-Private Partnerships Authority to transform, modernize and operate Puerto Rico’s 30,000 km electricity transmission and distribution system over a term of 15 years after a one year transition period, which commenced in the second quarter of 2020.

Stock Performance

1-Year Daily Price Chart (as on September 11, 2020). Source: Refinitiv (Thomson Reuters). 

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 32.19% and strategic ownership in the company stood at 32.19%, respectively.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to EBITDA Based Valuation Metrics

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

Stock Recommendation: The company’s business model is defensive in nature with a diversified customer base. Approximately 79% of the group’s exposure is to investment-grade customers. The company has solid financial strength, with a cash position of approximately CAD 1.14 billion and more than CAD 2.5 billion of cost-effective available credit facilities. The current liquidity seems sufficient enough to meet the group’s near-term requirements.  

The company has solid fundamentals and reported EBITDA margin above 35% over the last five years and outperformed the industry peers at the same time.  Also, the company’s ROCE is approximately 250bps higher than its Weighted Average Cost of Capital (WACC); this reflects the financial prudence of the management. Also, the company had investment graded credit ratings from the credit ratings with a stable outlook. Investment-grade credit rating is imperative to the company’s financing costs as it helps in access to the capital markets at a very competitive rate.

Further, at the last traded price, the group’s share its shares are offering a lucrative dividend yield of 4.4%, which is lucrative from an Income Investor’s point of view amid falling interest rate environment.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a “Buy” recommendation at the closing price of CAD 39.63 (on September 11th, 2020), with lower double digit upside potential, based on the EV/EBITDA multiple of 9.64x, on the FY20E EBITDA. We have considered Emera Inc, TransAlta Corp and Capital Power Corp etc., as a peer group.

 

*Recommendation is valid at September 14, 2020 price as well.

*Please be aware dividend is variable and not guaranteed.

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Disclaimer

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