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Compared to the S&P 500, which has rallied 10% year to date, the utilities sector has been an outperforming sector rallying 13% year-to-date. Further, the Utilities Select Sector SPDR (NYSEARCA:XLU) is trading at 52-week highs. However, some utility companies have not shared the same fate, including Atlantic Power (NYSE:AT). Although this company enjoyed the favor of dividend-oriented investors due to hefty monthly dividend returns, its situation changed at the beginning of March. Its price-per-share fell from $10.00 to $7.00 in one day. The company announced in its annual report the reduction of its payout ratio, which resulted in investors losing their confidence in the company. Although investors do not show mercy to companies who reduce their dividend, several articles still suggest that a long position in Atlantic Power should be considered. Therefore, I have decided to share my research on its most recent 10-K filling, and to discuss why I believe Atlantic Power should not be considered for a long position.

Note: When reading the statements, (p. X) means the 10-K page where the information is discussed.

Atlantic Power, a Canadian-based utility company, is a corporation dedicated to the production and sales of electricity, mainly through "Power Purchase Agreements". It operates power generation facilities in Canada and the United States. On the fundamental point of view, it is trading with a P/E of 1.85, and a dividend of 7.91%. Also, it is trading below its book value of $6.11. Further, its balance sheet shows a considerable debt, with a debt ratio of 0.23. On valuation, this company may appear to be a door-buster deal to investors; however, several issues that point to a risky future will be discussed.

By delving into its 10-K filling, several issues have led me to adopt a bearish position in this company. There are several risks associated with energy production and sales that will be discussed. Moreover, the company is being investigated by the IRS, and it has also been sued by a law firm. Further, other issues may push its PPS to new 52-week lows.

Risks associated with energy production and sales

Production Risks

According to its most recent earnings report, 58% of the company's electrical power output is generated by natural gas power plants (p. 3). Although the company has hedged against natural gas prices volatility, an increase in the natural gas prices will reduce its net income (p. 21). Natural gas prices have increased 33% year to date. Moreover, the company has completed the acquisition of "Ridgeline Energy". These facilities compose of wind and solar farms. The company generates 24% of its electrical power output through eolic power stations. In other words, if the winds are not favorable in the wind farms, the company's net income will decline (p. 23).

Sales Risks

Atlantic Power sells the majority of its power output through "Power Purchase Agreements". However, these contracts may be terminated before maturity, which would hurt the company's net income (p. 19). Besides, three PPAs are expiring in the next few years. However, even if the contracts are renewed, it does not guarantee that the company will sell its electricity at current or higher prices. If the agreement is not renegotiated, the company will see substantial losses in its net income. Further, the excess production may be sold to the grid at on-spot electricity prices, but electricity prices depend on supply and demand. Weather has an impact on electricity prices (p. 22). If the summer average temperatures are above average, customers expend more electricity for cooling purposes. Conversely, winter average temperatures should be below average, so customers consume more electricity on heating systems. Net revenue will increase only if electricity prices increase.

Legal risks

In 2011, the Internal Revenue Service began an examination on the company's federal income tax returns for fiscal years 2007 and 2009 (p. 41). On April 2, 2012, the IRS issued various Notices of Proposed Agreements. Although the company intends to contest the proposed adjustments, the dispute conclusion may not favor the company. Further, several law firms have initiated class lawsuits against the company on behalf of investors. The complaint alleges that the company made false/misleading statements, or failed to disclose material adverse facts about the Company's business, operation, and prospects. These prosecutions will drive the stock's price-per-share lower.

The Board of Directors may be a risk

Secondary public offers dilute the stock's price-per-share. The company stated that "From time to time, we may decide to issue additional common shares" (p. 37). On July 5, 2012, the company closed a public offering of 5.5 million shares. In my opinion, I do not like companies that have secondary offerings schemed in their futures.

In addition, the company stated that the dividends are not guaranteed (p. 35). From my point of view, future dividend cuts may be on the company's future plans. Investors had Atlantic Power in their radar because it is a monthly-dividend company, but now that dividends have been cut, and future cuts are possible, dividend-seeking investors will look elsewhere.

These situations will put pressure on the stock's price-per-share.

Performance year-over-year

The company's performance according to the most recent earnings report may be visualized in the following table (p. 45).

In millions of dollars

2012

2011

Net Revenue

$444.30

$93.80

Net income

($31.90)

($5.40)

Diluted EPS

($0.97)

($0.50)

The company's net loss increased from $5.40 million in 2011 to $31.90 million in 2012. Until the company reports a positive net income, long positions should not be considered in this stock.

Conclusion

Atlantic Power was a company favored by dividend-seeking investors before its most recent earnings report. In this manuscript, I have underlined key aspects from its 10-K filling. The company carries substantial risks involving electricity production and sales. Furthermore, it is being investigated by the IRS on its tax income returns for 2007 and 2009. In addition, several law firms started class lawsuits against Atlantic Power for failing to disclose information about the company's business. Furthermore, future dividend cuts may be in the company's future plans. In addition, the board of directors hint about the possibility of secondary public offerings. For these reasons, a sideways to bearish approach on this company ought to be considered.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: What You Should Know About Atlantic Power