Atlantic Power: Biomass Exposure, 7.4% Yield and Dependable Monthly Income

| About: Atlantic Power (AT)
Atlantic Power (NYSE:AT) is a Boston based, Canadian domiciled electric merchant power producer offering an intriguingly high dividend yield. For income investors, AT should be on your list to research, focusing on holding the position in non-tax deferred accounts.
As a Canadian company, US individual investors should be subject to foreign withholding / dividend tax of 15% that can be offset as "foreign taxes paid" when filing annual US tax forms, if held in taxable accounts. In IRAs or 401(k) accounts, as AT is a stock corporation, withholding tax potentially should not apply, but my personal experience is it may be difficult to convince your broker of such. Foreign withholding taxes generally apply to non-corporate Canadian structures, such as unit trusts and REITs, regardless of the type of account, and to foreign companies that trade as ADRs. The easy method of ferreting this out may be to hold AT in a taxable account that will offer offsets on your 1040 filings, but always check with your accountant and your broker before committing capital to an initial AT investment.
AT offers C$1.09, or USD$1.12, in annual dividends, for a 7.4% current yield based on a stock price of $15.18. The dividends are paid monthly. There are several reasons for AT to offer such a high yield.
Atlantic Power owns 12 power generation facilities in the US: 1 hydroelectric, 1 coal, 1 biomass, 1 wind, and 8 natural gas. In addition, the company owns an 84-mile transmission system in California. Total operating capacity is 871MW. 50% of its capacity is located in Florida, with the balance spread out over 9 other states. 75% of its capacity is fired by natural gas, 12% by coal, 6% each by biomass and wind, and 1% by hydro.
AT usually negotiates long-term power purchase agreements (PPA) with 95% of current production contracted until 2013. Fuel cost pass-through provisions are usually a component of their negotiated PPAs and the average contract length remaining is a bit over 9 years. The vast majority of clients are financially secure regional utilities, such as Progress Energy (PGN), Idaho Power, and Consolidated Edison (NYSE:ED).
Founded in Nov 2004, AT has been purchasing facilities based on either a roll-over of an existing, lower-priced PPA or an undervaluation based on inefficient operations. Profitability has suffered as AT built their business to critical mass and was only recently able to flip a few of their PPAs to higher levels. However, it seems better times may lie ahead.
Atlantic Power is expanding into the biomass generation business through majority ownership of a biomass construction and operating firm, Rollcast Energy, along with purchasing its own biomass generation facilities. Rollcast Energy currently operates five biomass facilities. With federal and state incentives of grants up to 30% of qualified costs for new renewable power facilities, AT is becoming well-heeled in this growing business. When the latest project in Georgia comes on-line late next year, biomass will represent 11% of generating capacity. The company has announced its desire to add another facility to the list by year’s end and when that facility comes on-line in 2013, biomass could represent 16% of capacity.

Some believe there could be a consolidation in the biomass generation industry as there are about 30 owners of 110 facilities. Atlantic Power could be well positioned to capitalize on both the growth and consolidation of this niche power generation business.
50% of overall capacity is located in Florida, and recent declines in residential and commercial electric consumption seem to be bottoming. As the economy of Florida slowly improves, so will demand at AT’s four large natural gas plants, positively impacting cash flow. A large PPA in Florida is set to expire in 2013, and an improving demand forecast could aid in negotiations.
Atlantic has been growing through acquisitions and by expanding its equity base thorough common and preferred stock sales. The company holds relatively little long-term debt at $350 million, compared to a market capitalization of $1 billion, based on 68 million shares outstanding. By 2014, management has set a goal of reducing l-t debt to $250 mil, which would translate into half their facilities being l-t debt free.
Due to high depreciation allowances, Atlantic Power is best reviewed by its operating cash flow or free funds from operations. While the company reported GAAP earnings per share of C$0.28 last year, management generated cash flow of about C$1.20 per share. This year, management projects to generate cash flow of C$1.17 to C$1.32. Based on current estimates, cash flow could expand by 4% to 7% annually over the next few years, giving support to shareholder distributions. Reported earnings are anticipated to remain relatively flat.
The high dividend seems safe, but probably won’t be raised until 2012 or 2013. Management has a stated goal of “maintaining the stability and sustainability of the dividend” and believes the current payout is covered until at least 2016 without further acquisitions or organic growth.
Shares have been trading on the NYSE since July of 2010. For income investors seeking to stretch their yield, Atlantic Power seems like a candidate worthy of further due diligence. While not anticipating much in the form of capital gains over the next few years, a 7.4% annual cash return, paid monthly, could be attractive.
As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.