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Investment Summary
We are initiating coverage on the Power Trust group with an Underweight
position among our pipeline, utilities and power coverage universe, effective
February 15. Our relative recommendations and price targets for the power trust
group are outlined in Exhibit 1.
The power trust sector’s rich valuation is the main driver behind our negative
bias at this time. The group’s cash flow multiples are at a premium to the other
energy infrastructure trusts and corporations, at over 11x EBITDA versus group
averages at 10x and 9x, respectively. We do not believe that this valuation gap
is sustainable based on inferior power assets, limited growth visibility, and rising
risk profiles.
We also think that most of the power trusts are too expensive to attract
premium takeout bids by financial and/or industry players. Our analysis
suggests that leveraged pretax equity returns of 5%–12% are not high enough
to justify leverage buyouts (LBO) of most of the power trusts. Mergers among
some of the power trusts may make sense for economies of scale and improved
diversity, but we foresee limited upside from cost synergies alone. Sector
consolidation may emerge as a theme among the power trusts over the coming
years, but timing is hard to predict as a catalyst over the next 12 to 18 months.
As such, we focus our attention on the potential for the power trusts to create
value as stand-alone entities. Most of the power trusts have little organic growth
potential with their existing assets. However, we show that there can be some
modest value creation for the group simply by adding more leverage to sustain a
low cost of capital in a taxable environment. But only some of the power trusts
have the opportunity to utilize their balance sheet capacity and create significant
value through acquisitions from their parent companies/financial sponsors. We
see this strategy as providing unitholders with the most “bang for their buck” in
a taxable environment – using leverage to finance growth opportunities can add
value through higher accretion (via lower after-tax cost of capital) while building
up tax shields.
In this context, we recommend owning only a few select power trusts with
visible growth prospects and a lot of balance sheet room to increase leverage.
Northland Power Income Fund (NPI.UN–SO) stands out as a value play, given its
visible acquisition opportunities and sector-low payout and capital structure.
We recommend reducing positions in the power trust group relative to our
coverage universe. Holding select power trusts for yield may still make sense,
but most of the power trusts appear fairly valued to over-valued at current
levels.
Table of Contents
Investment Summary.............................................................................3
Power Trusts Assets Are Inferior To Other Energy
Infrastructure Trusts… Yet Are Trading At Premium
Valuation ................................................................................................4
Valuation Could Hinder M&A Activity / Private Equity
Takeouts.................................................................................................7
Leveraging Up To A More Optimal Capital Structure Creates
Some Value In Taxable World...............................................................11
Those Select Few Power Trusts With Visible Growth
Opportunities Can Still Create Unitholder Value ...................................15
Underweight Power Trust Group Relative To Other Energy
Infrastructure Trusts............................................................................18
Appendix I. Moving To An Optimal Capital Structure In A
Taxable Environment............................................................................19
Appendix II. Canadian Electricity Markets Overview ............................21
Ontario................................................................................................ 21
Quebec................................................................................................ 23
Alberta ................................................................................................ 24
British Columbia ................................................................................... 25
Appendix III. Comparative Valuation ...................................................27
Appendix IV. Trusts Versus Stocks .......................................................28
Company Reports
Algonquin Power Income Fund................................................................ 30
Boralex Power Income Fund................................................................... 43
Countryside Power Income Fund............................................................. 57
EPCOR Power LP ................................................................................... 69
Great Lakes Hydro Income Fund............................................................. 81
Innergex Power Income Fund................................................................. 91
Macquarie Power & Infrastructure Income Fund...................................... 103
Northland Power Income Fund.............................................................. 118
TransAlta Power, L.P. .......................................................................... 131
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