Should You Buy AQN Stock for its 8.5% Dividend Yield?

Debt-heavy utility companies are trailing the broader markets by a wide margin as investors remain worried about the rising cost of debt. Several central banks have hiked interest rates significantly in the past 20 months to offset inflation and reduce the money supply in the economy. But it has also resulted in a rise in interest expenses and lower consumer spending.

One such TSX stock that is under the pump is Algonquin Power & Utilities (TSX:AQN). Down 67.5% from all-time highs, AQN stock currently trades at a market cap of $4.81 billion and an enterprise value of $16.1 billion, which suggests its net debt is over $11 billion.

The drawdown in share prices has increased AQN’s dividend yield to 8.5%, given it pays shareholders an annual dividend of $0.59 per share. Let’s see if you should buy the TSX dividend stock for its tasty dividend yield in late 2023.

Is AQN stock a good buy right now?

A renewable energy and utility company, Algonquin Power & Utilities has over $17.6 billion of assets in North America and other international markets. It provides regulated electricity, water, and natural gas utility services to 1.2 million customer connections, mostly in North America. Its growing portfolio of wind, solar, hydro, and thermal power-generation facilities represents 3.9 gigawatts of renewable generation capacity in operation and under construction.

In the first six months of 2023, Algonquin Power & Utilities increased revenue by 4% year over year to US$1.40 billion. However, its adjusted funds from operations fell 8% to US$367.8 million, while interest expenses surged by more than 40% to US$171.6 million.

Algonquin Power had already reduced its dividends by 40% in early 2023 due to rising interest expenses and lower cash flows. Despite the dividend cut, the payout ratio for the company is still around 80%, which is worrisome.

In the last three years, AQN’s balance sheet debt has risen by more than 80% to fuel its expansion plans. However, its earnings have experienced a steep decline due to higher operating expenses and debt costs. Moreover, AQN’s times-interest-earned ratio has fallen from more than 12 in early 2021 to less than one this year. This ratio tracks the interest-paying ability of a company, and a higher ratio is favourable.

AQN to sell its renewable energy business

During the company’s second-quarter earnings call, AQN stated it is looking to sell its renewable energy business, which should provide it with liquidity to strengthen the balance sheet. AQN explained the sale would result in optimized growth for both its businesses and provide a lower cost of capital for the utilities segment.

Algonquin Power & Utilities has appointed JPMorgan as a financial advisor for the sale process. It also emphasized the proceeds of the sale will be used to repay debt and repurchase shares. According to AQN, the exit will turn it into a well-capitalized, pure-play regulated utility with stable cash flows and a steady growth outlook.

Priced at 10 times forward earnings, AQN stock is cheap due to its debt-heavy balance sheet. Analysts remain bullish on AQN and expect shares to rise over 50% in the next 12 months. However, if AQN is unable to maintain its dividend payout, investors may eventually have to brace for another dividend cut.

The post Should You Buy AQN Stock for its 8.5% Dividend Yield? appeared first on The Motley Fool Canada.

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Fool contributor Aditya Raghunath has positions in Algonquin Power & Utilities. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.