AltaGas Ltd. Subscription Receipts: ALA.R

Knowledge is power. It’s a fundamental truism in investing. All edge gained when investing comes when the buyer (/seller) believes they are better informed than the seller (/buyer). The more complex a security, the harder it is for the unsophisticated investor to gauge an investment’s payout. This has two interesting implications:

1. When a fund of complex securities is offered to individual investors they are more susceptible to fall for a fund manager’s spin and take their word for this difficult to understand (yet “once in a lifetime”) opportunity. In this case the complexity allows the fund manager to increase fees, thus fund managers prefer to buy said products leading to a inflated security prices  (think CDOs). For those who don’t sleep here is a paper explaining just that
2. Conversley, when left on their own, without the guiding hand of an expert, most retail investors will avoid complex investments all together, leading to suppressed security prices

Today I present to you AltaGas Ltd. Subscription Receipts (herein refered to as “receipts”) trading under the symbol ALA.R on the TSX. They offer a similar exposure as the common shares with a twist.

Who are they?

AltaGas is involved in the production and distribution of natural gas with half of their EBIDTA coming from Canada, and half from the US. Their EBITDA breakdown can be seen below from their recent presentation. Boring long-term contracts yada yada lets move on:

The subscription receipts began trading on February 3rd 2017 at a debut price of $31 per share and currently trade hands at $29.83. The receipts were issued to help fund AltaGas’s acquisition of  WGL Holdings. The acquisition is expected to close in June 2018, at which time, each receipt will be converted into one AltaGas share, in the meantime the receipts will receive the dividend equivalent of the common stock.

If the deal falls apart (it probably won’t) holders of the receipt will be returned the face value of the shares, $31.

Let’s analyse the payoff of both outcomes:

NO Deal!

In the event of no deal the holder’s return is equal to:

Dividends Received (15months*0.175) + Discount to Issue price (31-29.83) = 3.795/29.83 * 12/15 = 10.17% Annualized Return

Deal!

This is the much more likely scenario (95%+?), in this scenario the buyer receives 1 Share of AltaGas plus slightly higher dividends leading up to the conversion time. The nice part is that the AltaGas receipts trade at a material 3.85% discount to where the common shares currently trade. So what are AltaGas common stock worth?

Valuation

AltaGas common stock trades at a very cheap 8.7x 2017’s estimated normalized funds from operations and pays a very generous and quite stable 6.8% yield. AltaGas intends to hike this dividend between 8-10% for at least until 2021 on the back of their WGL deal which was highly accretive.

Put in other terms, ALA currently trades at 6.6x 2021’s FFO and that is assuming ALA’s stellar management team makes no further moves between now and then.

AltaGas’s FFO metric is a normalized cash flow metric so to reach a distributable cash metric we will net out interest costs, prefered share payments, interest expense and sustaining capital. The analyst estimates are pegging 2017 distributable cash at roughly 2.50 to 2.60 per share, these are actually slightly above my estimates so I will take the bottom end of that range, in which case, AltaGas trades at 12.39 x 2017’s distributable cash.

Performing a DCF using a 9% distributable cash growth rate until 2021, 5% there after for 10 years, a terminal growth rate of 3%, and a continuous discount rate of 11% we get an implied share price of 41.93 or 35.3% upside.

Supposing the deal goes through AND the stock hits fair value in 1 years time the total return will be equal to:
Discount of Receipt to Common Stock + Common Stock discount to fair value + Receipt Dividends

= 3.85% + 35.3+% + 7% = 46% Total Return

Bottom Line

AltaGas has a terrific management team who’ve generated meaningful returns for investors over time, being able to buy their shares at a discount is a quite compelling oppurtunity.

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