3/1/13: Four Solid Reports and More on Atlantic Power

By David Dittman • March 1, 2013

As we forecast in today’s first Flash Alert, Atlantic Power Corp (TSX: ATP, NYSE: AT) gapped down at the open of trading on the Toronto Stock Exchange (TSX) and the New York Stock Exchange (NYSE) to as low as CAD6.27 and USD6.07, respectively.

The stock has since rebounded in both Canada in the US, trading as high as CAD7.49 on the TSX and near CAD7.28 as of this writing. On the NYSE today’s high is USD7.28, though the stock has backed off to USD7.05 in early afternoon trading.

Subsequent to this morning’s Flash Alert and following the company’s fourth-quarter and end-year 2012 earnings conference call, we arranged a follow-up interview with Atlantic Power CEO Barry Welch. This conversation will take place early next week; we’ll write it up for the next issue of Canadian Edge, which will be published Friday, March 8.

To review results briefly, Atlantic Power reported record levels of project-adjusted EBITDA and cash available for distribution, while project cash distributions of USD275 million exceeded the high end of management’s guidance range by USD10 million. The payout ratio for 2012–100 percent–was also within guidance of 96 percent to 102 percent.

The most significant driver of the solid EBITDA and cash flow results was the addition of the 18 projects acquired as part of the Capital Power LP deal in November 2011.

Atlantic Power added 450 megawatts of capacity to its portfolio and now has net ownership of 2,117 megawatts in operation. The 2012 additions include the 300-megawatt Canadian Hills Wind project in Oklahoma, which came on line in December within budget and in time to qualify for production tax credits.

The acquisition of Ridgeline Energy in December added another 150 megawatts, including the 120 megawatt Meadow Creek wind project in Idaho, which also entered commercial operation in December. Ridgeline also brings with it a strong renewable energy team and a promising development pipeline.

Including recently announced asset sales as well as the addition of Canadian Hills, Piedmont and Ridgeline, the company’s remaining weighted average power-purchase agreement (PPA) life improved by nearly 60 percent to 11.4 years from 7.2 years.

Management continues to see significant project opportunities on the horizon, though, as we discussed in this morning’s alert, the need to preserve sufficient cash to fund deals that may present longer lag times from investment to realization of cash flows was one factor contributing to a new dividend policy.

As we noted earlier, effective with the March dividend payable on April 30, Atlantic Power will pay CAD0.03333 per share per month, or CAD0.40 per share on an annualized basis. That’s down approximately 65 percent from a prior monthly rate of CAD0.09583, or CAD1.15 per share on an annualized basis.

Management detailed the combination of factors that led to the dividend reduction including the expiration of the Ontario-based Tunis project’s contract and the lack of transparency with regard to provincial authorities’ handling of negotiations. This process is not trending well.

Elsewhere in Ontario, margins are being pressured due to higher tolls on a pipeline and reduced waste heat used by Atlantic Power’s projects in the province.

The loss of cash flows from the three Florida power plants the company recently reached agreement to sell as well as the anticipated sale of the Path 15 transmission line in California also had a “material impact” on cash flow forecasts. Re-contracting the Selkirk project in New York at something less than was previously anticipated also played a role, as did management’s evaluation of the impact on cash needs of a greater share of growth investments being made in earlier-stage construction and development projects.

Management concluded that it is “in the best interest of the company and the shareholders to establish a lower and more sustainable payout ratio that balances yield and growth and is at the same time consistent with our outlook for current and prospective projects under a range of scenarios.”

As we noted this morning, Atlantic Power is now a hold.

We’ll have more–including an overview of our conversation with CEO Barry Welch–in the March issue of Canadian Edge next Friday.

As we also noted in this morning’s Flash Alert, four CE Portfolio Holdings reported solid fourth-quarter and full-year 2012 results.

Here are the highlights. We’ll have expanded commentary and strategy in the March issue.

AltaGas Ltd (TSX: ALA, OTC: ATGFF) posted normalized funds from operations (FFO) of CAD112 million, or CAD1.07 per share, for the fourth quarter of 2012, up 78 percent from CAD63 million, or CAD0.73 per share, for the fourth quarter of 2011.

Full-year normalized FFO was CAD281 million, or CAD2.96 per share, up from CAD219 million, or CAD2.61 per share, in 2011.

Fourth-quarter results were driven by the Aug. 30, 2012 acquisition of Semco Holding Corp (SEMCO) and its natural gas utilities in Alaska and Michigan, which performed as expected. This was AltaGas’ largest-ever acquisition and it also represented the company’s first major foray into the US energy infrastructure business.

AltaGas also commissioned constructed the two largest natural gas processing projects in its history and made considerable progress on its three Northwest run-of-river hydro projects, which are expected to begin operating in 2014, with the 195-megawatt Forrest Kerr project starting up in mid-2014. The company also received all material permits and licenses for both the McLymont Creek and Volcano Creek projects.

The hydro projects are ahead of schedule and within budget.

Subsequent to the end of 2012, on Jan. 28, 2013, AltaGas and Idemitsu Kosan Co Ltd formed the AltaGas Idemitsu Joint Venture LP, which will pursue long-term natural gas supply and sale deals that satisfy rising Asian demand. First up will be the study of potential liquefaction facilities as part of a proposed project to export liquefied natural gas (LNG) to markets in Asia.

The opportunity to export gas from Canada to Asia is a big one, and AltaGas’ interests include the only natural gas pipeline from eastern British Columbia to Canada’s west coast, putting it in good position to begin exports ahead of any other project.

The LP also plans to develop a liquefied petroleum gas (LPG, or propane) export business, including logistics, plant refrigeration and storage facilities.

What management describes as “the renaissance of natural gas” should provide AltaGas with many opportunities to continue to add assets and build value for shareholders.

Interest expense for the fourth quarter 2012 was CAD21.6 million, up from CAD13.3 million a year ago due to a higher average debt balance of CAD2.6 billion versus CAD1.8 billion, offset by higher capitalized interest and lower average interest rates.

AltaGas invested CAD150 million during the fourth quarter, CAD147.5 million of which was growth capital. For 2013, estimated CAPEX for projects currently under construction and investment at the company’s utilities is expected to be between CAD350 million and CAD400 million.

Management expects the capital program to be fully funded from internally generated cash flow and over CAD770 million in available credit facilities.

During 2012 AltaGas declared dividends of CAD1.40 per common share, or 47.3 percent of normalized FFO.

Management noted that 2013 performance will benefit from the new assets added in 2012, but also cautioned that the company experienced some weakness in Alberta power and propane prices in early 2013due to warmer-than-usual weather.

Management forecast that if prices remain weak, the first quarter of 2013 will be “similar to the fourth quarter of 2012.”

AltaGas, which maintained its monthly dividend rate at CAD0.12 per share, is a strong buy for long term growth under USD35.

Artis REIT (TSX: AX-U, OTC: ARESF) reported a 27.8 percent increase in fourth-quarter net operating income (NOI) to CAD66.7 million compared to the fourth quarter of 2011, while 2012 NOI was up 31.5 percent to CAD240.4 million.

Funds from operations (FFO) for the three months ended Dec. 31, 2012, was up 37.3 percent to CAD39.4 million, while full-year FFO surged by 40.2 percent to CAD140.1 million.

On a per-unit basis FFO was up 3 percent to CAD0.34 in the fourth quarter and by 7.4 percent to CAD1.30 for 2012. The quarterly payout ratio based on FFO came down to 79.4 percent from 81.8 percent, while the annual figure decreased to 83.1 percent from 89.3 percent in 2011.

Adjusted FFO (AFFO) for the fourth quarter was CAD33.9 million, or CAD0.30 per unit, which resulted in an AFFO payout ratio of 90 percent. AFFO for the year was CAD122.7 million, or CAD1.15 per unit, good for an annual AFFO payout ratio of 93.9 percent.

The quarterly interest coverage ratio ticked up to 2.60 times from 2.25 times a year ago, while the annual figure was up to 2.45 times from 2.21 times at Dec. 31, 2011.

Artis closed the acquisition of nearly CAD1 billion in new assets during the year, boosting revenue, net operating income and cash flow, at the same time diversifying its portfolio geographically and by asset class. Management also improved per-unit financial metrics as well as overall leverage and interest-coverage ratios.

The REIT acquired a total of 58 commercial properties in 2012 for CAD990.2 million, pushing its gross book value figure to CAD4.3 billion as of Dec. 31, 2012, from CAD3.2 billion on Dec. 31, 2011. The portfolio now comprises 220 income-producing properties over approximately 23.38 million square feet of leasable area.

Management replaced a CAD60 million revolving acquisition line of credit that matured on Sept. 28, 2012, with a CAD80 million revolving credit facility that matures on Sept. 6, 2014.

Overall mortgage debt-to-gross book value came down to 47.3 percent from 50.7 percent, while total debt-to-gross book value was down to 51.5 percent from 58.1 percent.  The REIT’s weighted-average effective interest rate declined by 37 basis points to 4.42 percent from 4.79 percent, while its weighted-average term to maturity pushed out to 4.4 years from 4.0 years.

Management also noted that Artis has earned an investment-grade credit rating of BBB (low) from DBRS.

All in all Artis REIT is bigger and better diversified than it was a year ago, with a strong balance sheet to boot. Artis REIT is a buy under USD16.

EnerCare Inc (TSX: ECI, OTC: CSUWF) announced a modest increase in its monthly dividend rate, from CAD0.056 to CAD0.057 effective with the March payment, which will be paid in April. This is affirmation, in management’s words, of EnerCare’s “strong performance in 2012,” its “long-term stable financial structure” and “reductions in attrition” as well as “the confidence the board has in the company moving forward.”

Revenue from rentals and services grew by 5 percent to CAD256.13 million in 2012 from CAD243.91 million in 2011. Waterheater rental revenue was flat, while submetering grew by 22 percent.

An increasingly higher-return product mix offset continuing waterheater rental attrition. This latter factor improved in the fourth quarter of 2012 versus the fourth quarter of 2011.

The payout ratio for 2012 was 63 percent, up from 55 percent in 2012 primarily due to an increase in current taxes and a higher dividend rate.

The increase in submetering revenue resulted from an increase in billing units due to an increase in penetration levels in retro-fit buildings and new construction developments that were activated during the fourth quarter of 2012 as well as flow-through commodity costs.

The rentals business accounted for 73 percent of overall revenue in 2012, down from 76 percent in 2011.

Fourth-quarter total revenue was up 5 percent to CAD63.13 million. Rentals revenue for the period increased slightly to CAD46.13 million, primarily due to a January rate increase and improved billing performance, partially offset by the impact of net attrition.

Submetering revenue improved by 22 percent to CAD16.82 million, due to increases in the number of billable units and increased pass-through commodity changes.

Selling, general and administrative expenses ticked higher by 14 percent for the year on increased wages and benefits associated with the internalization of the submetering unit’s management functions was well as higher claims and bad debts on the rentals side. Interest expense was lower for the year.

Looking ahead, EnerCare continued to experience improved customer retention in the rentals business during the fourth quarter of 2012, and management is “encouraged by the positive trend in the last half of 2012,” though it expects attrition to remain volatile from quarter to quarter. Customer retention remains a critical area of emphasis.

The transition to a new customer care and billing system that drove costs higher in the fourth quarter will continue into the first quarter of 2013, though management did note a reduction in costs to administer submetering accounts.

EnerCare extended and “laddered” its maturities during 2012, establishing some flexibility for further reductions in leverage while cutting future interest expense.

Management also announced in January 2013 a 3 percent increase in its weighted average rental rate.

EnerCare, which is yielding 7.7 percent at current levels, is a buy under USD10.

Extendicare Inc (TSX: EXE, OTC: EXETF) recorded a CAD4.9 million increase in fourth-quarter revenue, excluding the impact of its exit from the troubled Kentucky market.

Average Medicare Part A and Managed Care rates registered their first year-over-year improvement–as well as quarter-over-quarter boost–in some time. And cash flow margins excluding adjustments in reserves for litigation rose to 10.7 percent of revenue, up from 9.7 percent a year ago and in the third quarter of 2012.

That’s an extraordinary performance for this provider of acute and long-term senior care services, especially considering the headwinds it’s faced in the US market due to sluggish economic growth, Medicare payment cuts and litigation risk in Kentucky.

And coupled with a sharp improvement in profit margins from Canadian operations, the result was a 16.4 percent year-over-year jump in the bottom line: adjusted funds from continuing operations (AFFO).

Fourth-quarter AFFO of CAD0.312 covered the CAD0.07 monthly dividend by a 1.49-to-1 margin, which translates to a 67.3 percent payout ratio. Despite full-year declines in both revenue and margins–in large part to US Medicare cuts–Extendicare’s 2012 payout ratio came in at just 85 percent of AFFO, or 71 percent excluding cash set aside for litigation reserves.

The company’s results demonstrate the success of plans put in action last year to slash debt and operating costs and reduce legal risks.

Management has now completed its exit from the troubled state of Kentucky, allowing it to avoid setting aside more money for potential claims. And the company reported a 1.8 percent increase in its “net market basket” of Medicare services, or 2.5 percent less a productivity adjustment of 0.7 percent.

That last item should produce USD6 million of additional Medicare revenue per year. That will nearly offset the estimated USD6.7 million annual impact of the 2 percent funding reduction that kicks in March 1 as part of Washington’s “sequester.”

It’s possible that this USD6.7 million may be mitigated going forward if there is a compromise on the US budget. Come what may, however, Extendicare appears to have already dealt effectively with yet another threat to its revenue, cash flow and dividend.

Looking ahead to 2013 numbers, the US continues to present challenges. Despite continued favorable demographics from an aging population, the soft economy is negatively affecting demand for services. And the company has received subpoenas from the US Dept of Health and Human Services and Office of the Inspector General regarding alleged violations of the Social Security Act.

Management has met with US Dept of Justice officials and currently expects no material adverse impact on its financial position or operations. But until this is settled, the issue could hang over the stock.

In my view, the yield of well over 11 percent is plenty of compensation for potential risk at this company, which continues to prove its ability to deal with tough conditions. The headwinds mean Extendicare still belongs in the Aggressive rather than the Conservative Holdings.

But these numbers are plenty to keep Extendicare a buy up to USD8 for risk-takers who don’t already own it.

Following are confirmed and estimated announcement dates for those Portfolio Holdings that have yet to report results. Links will take you to analysis of numbers from those that have reported.

Aggressive Holdings

Aggressive Holdings

  • Acadian Timber Corp (TSX: ADN OTC: ACAZF)–Feb. 13 Flash Alert
  • Ag Growth International Inc (TSX: AFN, OTC: AGGZF)–March 14 (confirmed)
  • ARC Resources Ltd (TSX: ARX, OTC: AETUF)–February In Focus
  • Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)–Feb. 22 Flash Alert
  • Colabor Group Inc (TSX: GCL, OTC: COLFF)–March 22 (estimate)
  • Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF)–March 15 (estimate)
  • Extendicare Inc (TSX: EXE, OTC: EXETF)–March 1 Flash Alert II
  • IBI Group Inc (TSX: IBG, OTC: IBIBF)–March 26 (estimate)
  • Just Energy Group Inc (TSX: JE, NYSE: JE)–February Best Buy
  • Newalta Corp (TSX: NAL, OTC: NWLTF)–Feb. 15 Flash Alert
  • Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)–Feb. 13 Flash Alert
  • Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–Feb. 27 Flash Alert
  • PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–March 7 (estimate)
  • Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)–March 7 (estimate)
  • Vermilion Energy Inc (TSX: VET, OTC: VEMTF)–March 4 (confirmed)
  • Wajax Corp (TSX: WJX, OTC: WJXFF)–March 6 (estimate)

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