www.globeandmail.com

The Globe and Mail
leaftheglobeandmail

  Atlantic Power in a tough spot

BENJ GALLANDER and BEN STADELMANN

Friday, May 9, 2014

In the classic Parker Brothers game Monopoly, the pair of utilities are the least exciting properties to own. Sure, the Electric Company brings in a decent amount of cash compared to the capital outlay (a yield of about 18 percent based on the probability of the dice), but it isn't going to be a focus of attention for the players.

In real life, too, utilities have a reputation for monotony, making them suitable for risk-averse investors. Nonetheless, a fair number of these companies make it to our contrarian watch list of the beat-up and forlorn.

One such candidate is Atlantic Power. The corporation had its IPO in 2004 as an investment trust at $10 a unit, at a time when tech was out and high-yield vehicles were in fashion. The original portfolio consisted of 15 assets with a generating capacity of 773 megawatts (MW), heavily weighted towards natural gas plants in the United States. In the early years, distributions were stable at about $1.00 and electricity output grew moderately to 988 MW by the end of 2008.

In the aftermath of the financial crash, one of the few sectors to attract investment was infrastructure, and Atlantic pounced on the opportunity. In 2010 a listing on the NYSE was attained and $160 million in capital was raised for a major push into wind and biomass energy. The following year, the acquisition of Capital Power Income brought three hydro projects into the fold and total capacity soared to 2140 MW.

The 2011 annual report glowed with self-congratulation. It bragged of a 194 percent total return since the IPO, a doubling of enterprise value, and an annual dividend of $1.15 per share.

For CEO Barry Welch, all the acquisitions were attractive, opportunistic and accretive and aligned with generating stable, sustainable cash flow. As for the future, the outlook for more growth was exceptionally bright due to "our reputation for bringing deals across the goal line."

However, the following year indicated some fumbles. Oh, the tone was still plucky, but suddenly terms like "portfolio rationalization" and "divesting non-core projects" joined the lexicon. Shareholders didn't seem to mind much, with the shares cruising at $14. The yield remained peachy. However, they missed what we'll call the "safety contrarian indicator."

One thing we have noticed in our long experience with stocks is that when a company highlights its outstanding safety record after barely acknowledging the issue in the past, it can be a red flag. Employee safety is obviously very important, but when management's talking points shift from growth and prosperity to not injuring their workers, it's a good bet that they are finding the task of running the business profitably to be a lot harder than they surmised.

Nonetheless, Welch continued to preach that the dividend was as safe as his employees. It wasn't. Without ceremony, it was slashed by two-thirds last March and the stock price did an imitation of a certain coyote without a parachute.

Last fall, we took a hard look at the stock in anticipation of it getting hammered by tax loss selling. However, we concluded that the danger level remained too high.

The main problem is that the dividend is still too generous for a money-losing enterprise, and efforts to de-leverage the balance sheet would lead to reductions in cash flow. However, the threat of bankruptcy did not appear prohibitive, so one of us picked positions in the convertible debentures, series A (due March 2017) and series B (due June 2017) at deeply discounted prices.

This year, the stock has performed dismally, hitting a 52-week low of $2.52 in February. Mr. Welch has a severe credibility problem on his hands, having made the complete transition from hero to goat.

Aside from a brief stint with an instrument manufacturer after graduating from university, Welch spent 15 years as a portfolio manager for a Boston-based financial firm before moving on for Atlantic's IPO. This may have served him well in the early days of collecting a hodgepodge of properties, but he seems out of his depth running an integrated power company.

This week, the company acknowledged that it has engaged Goldman Sachs and Greenhill to help it evaluate strategic alternatives. An outright sale would probably make the most sense, but will be difficult to orchestrate given the poison pill provision that was implemented after the dividend cut. After all, employee safety starts at the top, and those golden parachutes work a lot better than Wile E. Coyote's.


back