Just recently I wrote a very brief summary article covering Atlantic Power Inc. (AT), meant to overview the company's delightful set of assets which focus on wind, natural gas, hydro and coal. To my disappointment, I left many readers undernourished for not mentioning the company's financial health, and rightfully so. It seems there is much uncertainty regarding the sustainability of the dangerously high dividend, which yields 10.6%, and is paid monthly. In addition, the dividend has been increasing over recent years, while the company offers a 3% incentive for enrolling in the DRIP, enhancing the dividend to roughly 10.9% when enrolled.
By the last metrics released by management, the company was paying out 90% to 97% of cash flows in 2012 to support the yield. Not only are these ratios high, but the large range between the high and low implies some unpredictability, perhaps due to asset sales and the company's small size:(click to enlarge)
The question is, will the dividend be cut drastically going forward, kept the same, or slightly adjusted in the near term? A concrete answer is difficult to ascertain, as the company has been fairly quiet in the last couple of months despite monster asset sales of the Auburndale and Lake facilities for just over $100 M, because of failure to secure meaningful pricing of new PPAs (contracts) for the facilities. In the press announcement, President and CEO Barry Welch, said:
Given our projections that the Florida energy market will not recover in the near-term to allow us to secure economic power purchase agreements ('PPAs'), we concluded, after considering all available options, that the sale of Lake and Auburndale maximizes shareholder value...The average remaining PPA life of our portfolio, when taking into account the sale of the three Florida facilities and the proposed sales of the Delta-Person generating station and Gregory facility, will increase 19% from 9.7 years to 11.4 years.
It was nice of Barry to highlight the positives, but what about the negatives? Delta-Person and Gregory are only small natural gas facilities, so the effect of those sales will have little bearing on the dividend. However, it is indeed disturbing that the Auburndale and Lake projects were two of the three largest individual sources of EBITDA in 2011, representing a combined total of 21% for the year, while accounting for a total of 341 net MW of power output.(click to enlarge)
Facility Replacement on a MW Basis:
To replace the 341 MW reduction calculated above, AT has some projects in the pipeline as well as a recent acquisition of Ridgeline, a renewable development company in Seattle, WA, with approximately 1,000 MW of wind and solar projects under development. According to past estimates, the Canadian Hill project was expected to produce just shy of 300 MW of wind power, and Piedmont was expected to generate roughly 54 MW of bio power. However, on January 2, AT announced a pleasant update:
We are pleased to add 450 net MW of generating capacity to our portfolio with the addition of Canadian Hills and Ridgeline, an increase of 20%," said Barry Welch, President and CEO of Atlantic Power. "The acquisition of Ridgeline adds over 150 net MW of fully-operational wind generation to our portfolio...We expect the addition of the Canadian Hills and Ridgeline projects in December 2012, and the Piedmont project in the first quarter of 2013, will increase the average remaining power purchase agreement ('PPA') life of our portfolio by 38% from 7.2 years to approximately 9.9 years, as all five projects have PPAs of 20 years or longer.
It seems the 341 MW loss should be fully replaced by the 450 net MW gained from the Canadian Hills and the Ridgeline acquisition, so depending on the pricing per MW for these new projects and when the others are officially divested, it appears there may not be a substantial shock to the company's well being. This again assumes the pricing per MW of the projects are similar.
On a MW replacement basis, the Canadian Hill project and the Ridgeline acquisition should sufficiently substitute for the loss of the three sold Florida plants. By rough calculation, I determined the 450 net MW gain from new projects should offset the 341 MW loss, but the exact conclusion is unknown until the company determines an accurate timeline, effects on debt loads, etc. Also, this replacement is reliant on similar MW pricing, which at this point is too difficult to calculate accurately. Although these uncertainties are a definite negative for the stock, one positive is the immediate replacement of natural gas assets by wind and biomass facilities. This will further position AT's portfolio into one more focused on renewable energy while reducing natural gas exposure. In addition, the Ridgeline acquisition, which was bought for a net $88 million, opens the door to even further allocate AT's portfolio to solar and wind energy sources in the future.
I was enthused by management's plan to maintain the dividend as recently as October of 2012, but was thrown by its inability to accurately forecast the dividend coverage ratio, which ranged from 90%-97% just recently. I was unable to accurately determine if the dividend is subject to a reduction because of these unclear figures provided by management, especially considering the multiple sales and new projects coming online. In addition, I am concerned by its untimely silence on the subject over the past four months, despite the worst-case scenario sale of large assets coming to fruition. There will truly be much to be said on the impending conference call, scheduled for February 28 ( I hope ).
AT does have solid assets with fixed costs and fairly long-term contracts. However, the razor thin, uncertain coverage ratio is an unknown investors should be wary of. On a positive note, management definitely seems to value returning cash to shareholders. Still, I feel the uncertainty has outweighed the juicy yield, and the shares have traded violently. It is also noteworthy that the dividend has been fairly consistent for the past several years.
For those with limited a risk tolerance, waiting until management announces results and comments on the dividend on the conference call could be prudent. However, since I have a tolerance for risk, I recently initiated a small, partial position in AT after the large pullback from the mid teens. It is my opinion that the new projects coming online will more than compensate for the Florida sales, therefore sustaining the dividend. In addition, I also believe the Ridgeline acquisition provides clarity into the future of AT, considering the 1,000 MW of projects claimed to be in development.
As always, this article, which again is my opinion, should not be your complete guide to investing in AT, and your investment decision should be just that - yours. Good luck.
Disclosure: I am long AT.