What happened
Algonquin Power & Utilities (AQN 0.49%) stock plunged 51.7% in 2022, according to data provided by S&P Global Market Intelligence. If you look at its performance graph, it is evident the utility stock saw aggressive selling only in the latter half of the year, especially in the last quarter.
There's a reason behind this: Some of Algonquin's numbers and the things it said signal rough times ahead including a potential dividend cut, and that triggered panic-selling in the stock.
A crucial business update coming up on Jan. 12 could decide where Algonquin stock will head in 2023.
So what
While most utility stocks pay a dividend, Algonquin's high yield was a major attraction for investors -- although the stock currently yields 10% thanks to the dramatic drop in its price, its trailing dividend yield was 4.6% in 2021.
Algonquin's dividend looked sustainable, too -- between 2010 and 2021, the stock grew its dividend per share at a solid compound annual rate of 10%, and in May 2022, it increased its dividend by 6%.
In the second quarter, Algonquin reported strong year-over-year growth in adjusted earnings and acquired a renewable natural gas developer while also starting commercial operations at a wind facility. Over the next couple of months, the utility, which serves more than 1 million customers, confirmed it was on track to acquire American Electric Power's Kentucky utility and transmission businesses at a revised purchase price of $2.6 billion including $1.2 billion debt by January 2023.
Given how things were going, Algonquin's third-quarter earnings release was a shocker. Its adjusted net earnings slumped 25% and cash from operations fell 41% year over year as its interest expenses surged and some renewable energy projects were delayed.
What panicked investors, though, was Algonquin's guidance: It slashed its adjusted earnings per share (EPS) guidance for the full year to between $0.66 and $0.69 from its previous guidance of $0.72 to $0.77 a share.
To top that, Algonquin said it expects the challenges to continue into 2023, and is therefore "evaluating its longer-term targets and financial expectations."
The warning bell attracted multiple analyst downgrades and sent Algonquin stock tanking.
Now what
Dividend growth is sustainable only as long as a company can grow its earnings and cash flows. In the nine months that ended Sept. 30, 2022, Algonquin's dividend-per-share payout exceeded its net adjusted EPS. Although its adjusted funds from operations grew, it could feel the heat going forward for two reasons.
First, Algonquin's renewables business may not grow in 2023 given the ongoing delay in the construction and completion of some projects. The business contributed roughly 14% to Algonquin's revenue in the first nine months of 2022.
Second, higher interest rates are eating into Algonquin's bottom line. During its third-quarter earnings call, management revealed that 22% of the company's debt was subject to variable interest rates, and that a 100-basis-point increase would add $16 million to its annual interest expense.
Algonquin may have to borrow more debt to fund its Kentucky acquisition, and this could be the biggest hurdle to the company's growth and dividends. A dividend cut is also possible, and investors will know more when the company hosts its investor and analyst day on Jan. 12. Yet, even if management makes some hard decisions and the stock falls, investors should analyze whether the near-term pain could mean long-term gains for Algonquin.
