Pat McKeough recently replied to an Inner Circlemember looking for an opinion on the utility company. New wind- and solar-power projects have boosted its revenue, says Pat, but not its cash flow.
Q: Hi Pat: I own a large number of Northland Power shares. I am interested in your opinion. Regards.
A: NORTHLAND POWER INC. (symbol NPI on Toronto; www.northlandpower.ca) develops, builds, owns and operates natural gas-fired power plants, wind farms, solar projects and hydroelectric facilities.
The company switched its registration from an income trust to a corporation on January 1, 2011.
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Northland owns or has stakes in 1,394 megawatts of generating capacity, with an additional 642 megawatts under construction.
In May 2014, the company purchased a 60% stake in Project Gemini—a $4.1 billion wind farm in the North Sea, off the coast of the Netherlands. That development should generate 600 megawatts (Northland’s share is 360 megawatts) when it starts up in mid-2017.
Gemini has a 15-year deal to sell its power to the Dutch government. That cuts the investment’s risk.
As well, Northland owns 85% of the Nordsee wind project. It’s also in the North Sea and 40 kilometres off the German coast. RWE AG, a leading utility company, owns the remaining 15%.
This project’s first phase, Nordsee One, is a 332-megawatt (Northland’s share is 282 megawatts) wind farm. It will cost $1.8 billion to build and has a 10-year deal to sell its power in Germany under controlled rates. Operations should begin by the end of 2017.
With subsidies from the German government, Northland plans to build two additional phases over the next decade, Nordsee Two and Nordsee Three. Together, those last two projects would produce 670 megawatts.
The long-term outlook is positive for all three Nordsee phases. Germany wants to reduce its use of nuclear power and expects to get 35% of its electricity from renewable sources by 2020. The goal is to raise that to 85% by 2050.
Thanks to new power projects and acquisitions, Northland’s revenue rose 104.5%, from $356.1 million in 2011 to $728.1 million in 2015.
Cash flow soared 232.1%, from $54.9 million in 2011 to $182.2 million in 2015. The company sold shares to finance its construction projects. As a result, cash flow per share fell 22.5%, from $0.71 in 2011 to $0.55 in 2012. Cash flow per share then improved to $1.05 in 2013, and rose to $1.10 in 2014. It dropped to $0.99 in 2015.
The Dogs of the Dow is a flawed approach to investing
In the three months ended September 30, 2016, Northland’s revenue jumped 41.6%, to $265.7 million from $187.7 million a year earlier. That’s mainly due to the start-up of new wind- and solar-power projects.
However, due to higher construction costs and interest payments, the company’s free cash flow (cash flow less capital expenditures) fell 49.0% in the quarter, to $32.1 million from $63.1 million. Free cash flow per share fell 44.1%, to $0.19 from $0.34, on fewer shares outstanding.
Northland’s long-term debt jumped from $4.8 billion at the end of 2015 to $6.0 billion as of September 30, 2016. That’s a high 1.4 times its market cap. However, the cash flow from its new Gemini and Nordsee projects will let it pay down that debt over the next few years.
The company pays monthly dividends of $0.09 a share, for a 4.5% annualized yield. In the third quarter of 2016, dividends equalled 143% of its free cash flow, up from 73% from a year earlier. However, under the company’s dividend reinvestment plan, some investors choose shares instead of dividends so its cash payout ratio for the quarter was a more-reasonable, but still high, 106%. The payout ratio will likely remain above 100% until the Gemini and Nordsee projects begin operating, but for now, the current dividend appears safe.
The stock trades at 15.6 times this year’s forecast of $1.55 in free cash flow per share. Free cash flow could jump to $2.35 in 2018, and the shares trade at just 10.3 times that estimate.
Northland needs to successfully complete its new projects to increase its revenue and cash flow. Still, its operations are spread across four separate regulatory areas. That limits its risk. Its long-term contracts also provide stability.
Inner Circle recommendation: Northland Power is okay to hold.
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