Atlantic Power's Debt Burden Looms Large Over The Stock

| About: Atlantic Power (AT)
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Few positive things can be said about Atlantic Power (NYSE:AT). During much of 2012, Atlantic Power repeatedly reassured its shareholders about the safety and sustainability of its dividend before then slashing the dividend 65% on February 28, 2013. Atlantic Power also vastly understated the concentrated nature of its distributable cash flow. In addition, soon after reducing the dividend, Atlantic Power adopted a shareholder rights plan, also known as a 'poison pill', which is widely seen as a defensive tactic to deter a potential takeover. The market has not reacted kindly to these events, with Atlantic Power's stock down a massive 66% YTD. However, Atlantic Power still has several major downside risks, mostly associated with its large amount of debt.

Overview

Before I dive into Atlantic Power's risk factors and operating metrics, let us take a look at its current assets. Atlantic Power owns and operates several power generation facilities throughout the US and Canada. The company also owns other power generation related assets, including transmission infrastructure and minority stakes in other plants. The majority of Atlantic Power's adjusted EBITDA and distributable cash flow comes from its Northeast segment. Atlantic Power uses power purchase agreements, or PPAs, as part of its business model. These PPAs allow the company to lock in cash flow for years. However, these contracts also expose the company once they expire.

Adjusted EBITDA and Dividend

Atlantic Power saw a sharp fall in profitability after it sold its Florida assets. These assets represented about 33% of its FY 2013 adjusted EBITDA. However, Atlantic Power did have projects coming online in 2013 which mostly cover this EBITDA decline. Using the midpoint for Atlantic Power's FY 2013 guidance, the company projects a 22% decline in FY adjusted EBITDA, from $333M in 2012 to about $263M in 2013.

However, adjusted EBITDA is not a good measure for determining the safety Atlantic Power's dividend. Atlantic Power uses a metric called 'cash available for distribution', which I will refer to as DCF, to determine its dividend. This metric is in no way correlated to Atlantic Power's adjusted EBITDA. For FY 2012, Atlantic Power generated about $132M in DCF. However, the Florida assets represented an outsized chunk of this total. When removing these assets, Atlantic Power's DCF drops to about $55M, a decline of nearly 60%. To summarized: the Florida assets only represented 33% of adjusted EBITDA, but about 60% of DCF. Atlantic Power only received about $110M for the Florida assets, or less than 1x FY adjusted EBITDA. In essence, Atlantic Power traded away most of profitability when it sold these assets.

When discussing its FY 2013 DCF guidance and payout ratios, it should be noted that Atlantic Power adds cash flow from discontinued operations to this metric. This is, in my opinion, a very unsavory tactic. By definition, these cash flows are not recurring. They will not be replicated in future years and are by nature one-time benefits. Therefore, I will be providing both an adjusted and non-adjusted version of these figures.

Using Atlantic Power's numbers, it projects a dividend payout ratio of about 65% to 75% for FY 2013. However, as noted above, this figure includes cash flow from discontinued operations. Using the pro-forma basis, which excludes $44M in cash flow generated by the sold assets and adjusts the dividend for the new monthly rate of $0.033, Atlantic Power's payout ratio deteriorates to about 100%. This would put Atlantic Power current dividend firmly into the "high-risk bracket".

However, neither of these metrics capture the true nature of Atlantic Power's dividend. Below is a chart that combines two things: it excludes the $44M in cash flow from discontinued operations and includes the 2 months of the previous dividend rate of $0.9583 per month. Note that this chart uses the midpoint for Atlantic Power's DCF from continuing operations, which can be seen in the above chart. This number is about $48.5M, or about $4.05M per month.

Major Risk Factor: Massive Debt Load

Even with its stock price in the gutter, Atlantic Power still carries outsized risk. Atlantic Power has a massive amount of debt coming due in the next few years.

As shown above, Atlantic Power has about $235M in debt coming due in 2014. This includes about $190M for its Curtis Palmer subsidiary debt and $45.8M (Canadian dollars) of convertible debentures, for a total of about $235m.

How will Atlantic Power repay these debts? Well, the answer is a combination of about 50% debt and 50% equity, as shown below:

To fund the equity portion, Atlantic Power would need to dilute its shareholders massively. 50% of $235 is about $118M. Using its current share price of about $4, Atlantic Power would need to issue at least 29.5M shares, or about 26% of its float, not including the likely discount needed to sell these shares or any related fees.

Considering that Atlantic Power's current payout ratio is hovering around 100%, it seems unlikely that the company would be able to issue this many extra shares without further dividend cuts. Also note that Atlantic Power has several other large amounts of debt coming due in future years, including its massive $460M high yield unsecured notes due in 2018. It is questionable as to if anybody will even buy a high-yield bond from Atlantic Power considering its current indebtedness.

The question regarding debt refinancing was brought up during Bank of America Merrill Lynch Global Energy and Power Leveraged Finance Conference. (here is a link to the transcript). Below is Atlantic Power's CFO Terrence Roman's answer to the question:

Terrence Ronan - Executive Vice President and Chief Financial Officer

Sure. Well, we have a maturity of our first common note in July of 2014. That's about $190 million and our plan today would be to do that with a combination of debt and equity if the capital markets permit. If they don't, the fallback would be project finance. We do want to reduce leverage over time that would amortize over time. We'd like little bit more than that. And then secondly, we have a convert that comes due later in 2014 and our intent would be to roll that in the covert market, if that market is not friendly, then our plan would be to do that on to our high yield transaction.

Again, it remains questionable if Atlantic Power will even have access to the high-yield debt market. If the company has trouble refinancing $190M in debt, imagine the trouble it will face when it has to deal with the other large debts due in 2015, 2017, and 2018.

Conclusion

Due to its history of misleading investors about the safety of its dividend, its weak operating performance, and massive debt, Atlantic Power is an uninvestable stock. Atlantic Power's total liabilities are nearly 6 times greater than its current market cap. Even after cutting the dividend 65% earlier this year, Atlantic Power's payout ratio is still hovering around 100%. Even with its large yield, Atlantic Power has massive risk and should be avoided.

Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.

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.