AT - Atlantic Power Corp

[awindenberger]

In speaking with the CEO, he seems really excited by the possibility of not only getting a transfer of value from debt to equity but also getting a move higher in power prices and multiple expansion. The trifecta makes things really interesting. One thing that supported the idea is that asset sales prices are well ahead of current EV/EBITDA multiples suggesting the public market has a lower valuation than the private market which should rationalize over time (one way or another!).

 

I own a lot of the AZP.PR.C so I haven't bought the equity yet but I did buy Calpine (CPN.N) under a similar thesis.

 

How recently did you speak to the CEO?

[SafetyinNumbers]

It was the last AGM.

[Cardboard]

They missed their project EBITDA guidance with $202.2 million vs $205-$215 million for the year due to a few one time items but, I really like their 2017 guidance at $225-$240 million:

 

http://www.stockwatch.com/News/Item.aspx?bid=Z-C%3aATP-2449090&symbol=ATP&region=C

 

As they follow their plan to repay $150 million or more of debt in 2017, the thesis of shifting EV to shareholders vs debt holders will really start to play out. I would expect debt upgrades along the way too.

 

Cardboard

[SafetyinNumbers]

With only about 115m shares outstanding, its not hard to move the needle!

[SafetyinNumbers]

Management posted its prepared remarks from the upcoming conference call.

 

Good reading from page 25 on how the CEO thinks about the business.

 

https://s3.amazonaws.com/filecache.drivetheweb.com/mr5ir_atlanticpower/195/download/03.02.2017+ATP+Q4+2016+Prepared+Remarks+FINAL.pdf

[SafetyinNumbers]

Conference call was pretty interesting. My favourite part was suggesting if they had debt levels at their long term targets they would do a substantial issuer bid versus the slower normal course issuer bid they are doing now.

 

Well based on their guidance, they will be at 4x debt/EBITDA by year end so that should open them up to doing a SIB next year potentially.

[flesh]

A nice tidbit from the prepared remarks.

 

"A few brief remarks on growth before closing. At Atlantic Power, we have a

management team that has a long and successful track record of growing power

businesses. Until recently, however, the Company has not had the financial

strength to credibly pursue growth. We now believe we have the capacity to

consider modest investments, but the wholesale power market is for the most part

still frothy.

One key trend that we’ve observed is that wholesale power prices have come down

significantly but industrial customer rates have been sticky. Organic development

of new long-term contracted plants with industrial customers (under which we

would sell heat and power) is expected to provide a better risk-return profile than

wholesale market opportunities. We have expertise in this area, including

operations, fuel supply management and knowledge of merchant power markets, as

well as strong relationships with industrial customers at several existing sites.

The smaller size of the projects would also fit better with our capital availability.

We’re in the early stages of implementing this strategy, and we don’t expect to

have anything concrete to report for a while. "

 

"Morris was our first significant PPA renewal in several years. The run rate

EBITDA contribution under the PPA extension with our industrial customer is

more attractive than what we have seen from utilities. Understand, though, that the

existing PPAs provide for a return of and on our capital to finance construction.

Interest rates were much higher when they were signed. From a customer

standpoint, our original investment in the plants has been recovered and therefore

the cost of power from our plants should be lower on a renewal. However, for

some of our plants, an extension of the PPA will require that we make incremental

investment in the plant. We will require good returns on this incremental

investment or we won’t do those deals.

PREPARED REMARKS

Q4/YEAR END 2016

36

The larger point is that in the United States, the high penetration rate of

intermittent power sources has kept retail rates (end-user prices) high at the same

time that wholesale power prices have declined by forty percent or so in some

cases. We have, therefore, shifted our focus toward the industrial markets. We are

working with industrial customers at our existing facilities to provide them lowcost,

reliable, clean power. We also have begun to seek new plant opportunities

with other industrial customers. We think that this makes sense based on the

current structure of the power markets and it is a market segment that is well

within our core competencies, while the investments are of a size that will attract

less interest from the large IPP players but which can move the needle for Atlantic

Power. We have begun to allocate some of our people in this direction and as we

proceed we may add some development expense which would be very modest in

2017. We will be putting in mostly sweat equity at this point. Depending on how

things evolve, we ought to be able to give a more specific update at the end of the

year.

When we worked together previously, Joe Cofelice and I were able to capture $160

million of value from private transactions by growing off a much smaller capital

and resource base than we have at Atlantic Power. That isn’t a forecast but it

points out that here we have adequate resources and experience to grow this

business. If we are successful, we would then have a fourth case which would be

GROWTH to go along with the other cases. It is too early to make any promises

on this front but we are very enthusiastic about this effort."

 

[SafetyinNumbers]

Decent insider buy from Mr. Colefice.

 

https://www.canadianinsider.com/company?ticker=ATP

[SafetyinNumbers]

New article on Seeking Alpha

 

http://seekingalpha.com/article/4053875-atlantic-power-awesome-turnaround?v=1489098583&comments=show

[Cardboard]

AZP.PR.A has now lagged so much vs the other preferreds that it is now the best bet unless you can predict with certainty higher Canadian interest rates.

 

It now yields 8.25% in perpetuity vs 7.75% for AZP.PR.B and 6.9% for AZP.PR.B. Even if you adjust for AZP.PR.C catching up to the price of the AZP.PR.B in December 2019, the overall return is very similar. Some may argue that it is slightly better on a taxation standpoint but, I would not want to bet that AZP.PR.B will yield more than AZP.PR.A going into the future. You are paying 0.5% to simply bet that interest are going to move up. Hmmm...

 

It also has the largest gap to par trading at $14.75 vs $18.20 and $17.25 respectively. So if there is some buyback, I would think that it is where the company would repurchase first.

 

Cardboard

[SafetyinNumbers]

I see the AZP.PR.C still having an additional ~75bp return to conversion vs AZP.PR.B so it's meaningful and slightly higher than AZP.PR.A.

 

You are right though that AZP.PR.A might be better if you think buyback will be focused there, if the company will be bought out or if you think rates are going lower.

[Cardboard]

The way I do the math is that I look at all distributions that should be received over a 5 year period divided by 5, then divided by the price of the security that I am looking at. It gives me a yield or approximation be able to compare them. For the "C"'s, I assume conversion into the "B"'s in December 2019, the gain added as a distribution, followed by what the "B"'s would pay in distribution over the remaining period using current interest rates for the reset.

 

So based on today's close (and it has changed since my e-mail since the spread is large between bid/ask and where they end up trading) and current interest rates I get:

 

AZP.PR.B: 7.39%

AZP.PR.C: 8.58%

AZP.PR.A: 8.20%

 

So the "C"'s have a slight edge over the "A"'s looking through a 5 year period. However, that is again assuming that the "B"'s will keep on trading at a current yield of 7.45% which is 75 bp lower than the "A"'s. Seems like a lot of premium to me and the "C"'s are only attractive because of the "catch-up" to the "B"'s on the exchange in almost 3 years. And if I was running a DCF analysis, the "A"'s would look even better because they pay more right now.

 

So the discount to par is not even a major consideration. It is icing on the cake.

 

I never thought that I would look at the "A"'s but, they have lagged so much the other two that now it is different.

 

Cardboard

[gokou3]

I bought AT and AZP.PR.A earlier this week.  After going through this and the preferred threads (thanks for the great analyses!), Q4 transcripts, presentation, etc., I wish I had learned about this company earlier.  I think the consensus on this board is that the common is an equity stub of a company deleveraging quickly.  I figure that the equity value will be at least US$3.5 even under very draconian assumptions. In my model, I assume all cashflows go to debt repayment, no share purchases, no inflation, no asset sale, no debt interest rate improvement, no PPA renewal, and constant G&A / tax / capex.  I did assume a gradual increase in EV/EBITDA ratio.

 

One decent positive news that has not yet been discussed is the pending "windfall" stemming "from the Global Adjustment litigation brought by a group of Non-Utility Generators against the OEFC, which was decided in favor of the plaintiffs by the Superior Court of Canada." Per the "subsequent event" section of the 2016Q4 earning release, "the Company will be receiving a payment of approximately Cdn$8.4 million for its Kapuskasing and North Bay plants representing the application of the price escalator calculation under their respective PPAs for power sold to OEFC in 2016."

 

So two plants being offered C$8.4M for one year of the PPA (2016).  There's also a third plant (Tunis) that is also eligible for this adjustment.  Furthermore, adjustments are possible for the years 2011-2017 as well.  So extrapolating this offer to 3 plants over multiple years, the company could be looking at settlement in the ballpark of C$60-80M.  This is a pretty decent amount for a company with US$300M market cap.  Management said timing and amount are uncertain but I can't imagine this will take more than a year to close.  This amount of money if received soon enough can really pull forward the redemption of the debentures and then the common share repurchases.

 

Any thoughts?

 

 

[flesh]

I agree it could be huge, I put it in the bonus file. If the settlement is in the 10's of millions it will pull forward the equity/debt ev mix quickly.

 

Also, all the news is out now for ppa's through 12/2019 in terms of where they stand currently whereas before they were a potential red flag for investors. In otherwords, it should be priced in from now. In general I saw the last ec as a net neutral, pluses and minuses to my expectations and until there is some clear positive news will remain so. That said, it's very hard to see the equity not eclipsing 5/share in the next 2-3 years. There's a bull case for much better.

 

Cheers.

[netnet]

So it seems to me that what we have is

 

• an intelligent fanatic, who has made money before in this industry: that is good.
  
• He has an experienced management team: good (so if he is hit by a bus the company is still okay.)
  
• A capital intensive commodity business subject to cycles: generally bad but mitigated by the management who can play the cycle, so neutral.
  
• A low valuation: good
  
• This a turnaround that has started to turn: good
  

 

What would kill this idea:

• it is management intensive, so poor capital or operational issues could really hurt, it is not a great business. Probability 10%
  
• Terrible PPA contract renewals. Unknown %
  
• Really bad interest rate environment could hurt. 5%
  
• Inability to continue to deleverage. Probability ?
  
• Regulatory risk. 10%
   
   
   
  

 

[SnarkyPuppy]

Management is clearly great.  I'm just having trouble with valuation? 

 

Using 12/31/2016 numbers:

 

201.9 Total Project Level Adjusted EBITDA

-22.6 SG&A

-2.9 Capex (Slide 40 16Q4 earnings)

-86.7 Interest Expense (106mm corp + 10.9mm project level - 30.9 def financing charge)

= 89.7 FCF

 

1132 = Total Debt + Pref - Cash

1411 = 89.7 FCF + 86.7 Future Interest Expense Savings * 8x multiple

279 = Common Value

2.44 = Per Share Value (114mm shares)

 

Why would this company be worth anything more than 8x?  Ultimately this comes down to whether you think it's worth 8x or 10x which doesn't provide a ton of margin of safety.  The stub is highly sensitive to whatever discount rate you apply.  I suppose you could apply a higher multiple to the Hydro's cash flows based on the CEO's comments.

 

Also, it's difficult to become comfortable when 30% of Project Level EBITDA expires within the next 5 years.  This isn't news to anyone, but I'm struggling with how those who own the commons are comfortable aside from management being value oriented?  The preferreds seem much more attractive to me. 

[gokou3]

Management is clearly great.  I'm just having trouble with valuation? 

 

Using 12/31/2016 numbers:

 

201.9 Total Project Level Adjusted EBITDA

-22.6 SG&A

-2.9 Capex (Slide 40 16Q4 earnings)

-86.7 Interest Expense (106mm corp + 10.9mm project level - 30.9 def financing charge)

= 89.7 FCF

 

1132 = Total Debt + Pref - Cash

1411 = 89.7 FCF + 86.7 Future Interest Expense Savings * 8x multiple

279 = Common Value

2.44 = Per Share Value (114mm shares)

 

Why would this company be worth anything more than 8x?  Ultimately this comes down to whether you think it's worth 8x or 10x which doesn't provide a ton of margin of safety.  The stub is highly sensitive to whatever discount rate you apply.  I suppose you could apply a higher multiple to the Hydro's cash flows based on the CEO's comments.

 

Also, it's difficult to become comfortable when 30% of Project Level EBITDA expires within the next 5 years.  This isn't news to anyone, but I'm struggling with how those who own the commons are comfortable aside from management being value oriented?  The preferreds seem much more attractive to me.

 

It's true that EBITDA is expected to decline in the next 5 years, but also consider the value transfer from debt to equity as debt is paid down.  For example, management guided to a potential EBITDA drop of $60M in 3 years, i.e. from $200 in 2016 to $140M.  They also guided to a $400M debt pay down, thus from $1000M to $600M.  So, assuming EV/EBITDA=8 (comparable to peers currently), you would have EV = $1120.  Equity value would then be $1120-$600 = $520M or $4.5 per share.  You should reach a similar conclusion with the EV/FCF metric.

 

I would agree that the preferred is a much safer bet, especially with management having a meaningful stake in the lower-ranked common.

 

 

 

 

[gokou3]

What puzzles me is that retail electricity prices have gone up while wholesale prices (received by the IPP) are much lower.  How did that happen and who pockets the difference?  I imagine some has gone to the subsidy of renewable energy producers but is that it?

 

See example here for the Ontario market:

http://business.financialpost.com/news/energy/ontario-manufacturers-eye-greener-pastures-stateside-as-hydro-rates-go-through-the-roof

[Neversummer]

Everyone keeps pointing to the preferreds as a significantly safer bet than the common. In reality are they? It is my understanding they are issued out of one of the two main subs with no claim on the parent holdco so if the company were ever to file or shut down that sub the common would still have a cash flow back from the other sub. To me the prefs then seem like a sub bond issued out of a non recourse subsidiary. I am not saying the prefs may still not be safer but I could draw a scenario where the common has value and the prefs are a zero. Am I missing something?

[Cardboard]

"The Series 1 Shares, the Series 2 Shares and the Series 3 Shares are fully and unconditionally guaranteed by us

and by the Partnership on a subordinated basis as to: (i) the payment of dividends, as and when declared; (ii) the

payment of amounts due on a redemption for cash; and (iii) the payment of amounts due on the liquidation, dissolution

or winding up of the subsidiary company. If, and for so long as, the declaration or payment of dividends on the Series 1

Shares, the Series 2 Shares or the Series 3 Shares is in arrears, the Partnership will not make any distributions on its

limited partnership units and we will not pay any dividends on our common shares."

 

Cardboard

[Neversummer]

well then that sums that up :) thanks for fixing my brain

[winjitsu]

Management is clearly great.  I'm just having trouble with valuation? 

 

Using 12/31/2016 numbers:

 

201.9 Total Project Level Adjusted EBITDA

-22.6 SG&A

-2.9 Capex (Slide 40 16Q4 earnings)

-86.7 Interest Expense (106mm corp + 10.9mm project level - 30.9 def financing charge)

= 89.7 FCF

 

1132 = Total Debt + Pref - Cash

1411 = 89.7 FCF + 86.7 Future Interest Expense Savings * 8x multiple

279 = Common Value

2.44 = Per Share Value (114mm shares)

 

Why would this company be worth anything more than 8x?  Ultimately this comes down to whether you think it's worth 8x or 10x which doesn't provide a ton of margin of safety.  The stub is highly sensitive to whatever discount rate you apply.  I suppose you could apply a higher multiple to the Hydro's cash flows based on the CEO's comments.

 

Also, it's difficult to become comfortable when 30% of Project Level EBITDA expires within the next 5 years.  This isn't news to anyone, but I'm struggling with how those who own the commons are comfortable aside from management being value oriented?  The preferreds seem much more attractive to me.

 

FCF overwhelming accrues to the equity holders rather than the preferred holders. On $89.7M of FCF, only $9M is going preferred holders, leaving ~$80M to Equity. At a common value of ~$300M, that's 3.7x FCF. This is how I think about it anyways. 

 

Preferred vs Common comes down to if/when you think management will redeem the shares. As others have brought up, a levered preferred position may have better risk/return characteristics.

 

[SnarkyPuppy]

Management is clearly great.  I'm just having trouble with valuation? 

 

Using 12/31/2016 numbers:

 

201.9 Total Project Level Adjusted EBITDA

-22.6 SG&A

-2.9 Capex (Slide 40 16Q4 earnings)

-86.7 Interest Expense (106mm corp + 10.9mm project level - 30.9 def financing charge)

= 89.7 FCF

 

1132 = Total Debt + Pref - Cash

1411 = 89.7 FCF + 86.7 Future Interest Expense Savings * 8x multiple

279 = Common Value

2.44 = Per Share Value (114mm shares)

 

Why would this company be worth anything more than 8x?  Ultimately this comes down to whether you think it's worth 8x or 10x which doesn't provide a ton of margin of safety.  The stub is highly sensitive to whatever discount rate you apply.  I suppose you could apply a higher multiple to the Hydro's cash flows based on the CEO's comments.

 

Also, it's difficult to become comfortable when 30% of Project Level EBITDA expires within the next 5 years.  This isn't news to anyone, but I'm struggling with how those who own the commons are comfortable aside from management being value oriented?  The preferreds seem much more attractive to me.

 

FCF overwhelming accrues to the equity holders rather than the preferred holders. On $89.7M of FCF, only $9M is going preferred holders, leaving ~$80M to Equity. At a common value of ~$300M, that's 3.7x FCF. This is how I think about it anyways. 

 

Preferred vs Common comes down to if/when you think management will redeem the shares. As others have brought up, a levered preferred position may have better risk/return characteristics.

 

 

It's 3.7x FCF assuming Revenue stays the same.  I think that's the big "if"...    How do you have full confidence they can renew enough of their PPA's to be able to pay their debt down in full? 

 

Last time I looked at this, I basically took all of their PPAs and assumed renewal at 50% of current project level EBITDA at the next expiration.  This exercise made it seem questionable whether or not they can repay their debts through the next 5 years. 

[winjitsu]

 

It's 3.7x FCF assuming Revenue stays the same.  I think that's the big "if"...    How do you have full confidence they can renew enough of their PPA's to be able to pay their debt down in full? 

 

Last time I looked at this, I basically took all of their PPAs and assumed renewal at 50% of current project level EBITDA at the next expiration.  This exercise made it seem questionable whether or not they can repay their debts through the next 5 years.

 

Absolutely, but such a low number is what makes the equity interesting in the first place.

 

From Q4 Prepared Remarks:

 

"Although we have not shown projected leverage ratios on this slide, we believe that, assuming debt repayment of $150 million, we will be approximately 4 times levered by year end 2017 as compared to 5.6 times currently. By the end of 2020 we expect to be less than 4 times levered, or close to what we view as an appropriate level of leverage for this business."

 

Why do they need to pay down debt in full? From the quote above, they're targeting 4x leverage ratio (they define as debt / project ebitda - sga) as something that they're comfortable with long term. Also as outlined in slide 19 in the Q4 deck, they will have to roll over some of the maturities over the next 2-3 years, so in a sense you're right, but not sure why that's damning. Keep in mind, not all of the debt is recourse...

 

Despite not giving guidance to PPA renewal values, the company has basically given soft guidance to 2020 earnings. They expected to retire $400M of debt, leaving the company with $638M. At 4x leverage, the company is guiding towards $160M in EBITDA - SGA. Assuming $20M in SGA, thats ~$180M EBITDA.

 

Working off $160M (EBITDA - SGA), assuming $10M Capex, $50M Interest (~8% on $632M debt), that's still $100M in 2020 FCFE, of which $90M is going to common. Not to mention at this point, they'll be investing for growth. Slap on whatever multiple you want, but the bull case certainly has merits.

 

 

 

 

[SnarkyPuppy]

 

It's 3.7x FCF assuming Revenue stays the same.  I think that's the big "if"...    How do you have full confidence they can renew enough of their PPA's to be able to pay their debt down in full? 

 

Last time I looked at this, I basically took all of their PPAs and assumed renewal at 50% of current project level EBITDA at the next expiration.  This exercise made it seem questionable whether or not they can repay their debts through the next 5 years.

 

Absolutely, but such a low number is what makes the equity interesting in the first place.

 

From Q4 Prepared Remarks:

 

"Although we have not shown projected leverage ratios on this slide, we believe that, assuming debt repayment of $150 million, we will be approximately 4 times levered by year end 2017 as compared to 5.6 times currently. By the end of 2020 we expect to be less than 4 times levered, or close to what we view as an appropriate level of leverage for this business."

 

Why do they need to pay down debt in full? From the quote above, they're targeting 4x leverage ratio (they define as debt / project ebitda - sga) as something that they're comfortable with long term. Also as outlined in slide 19 in the Q4 deck, they will have to roll over some of the maturities over the next 2-3 years, so in a sense you're right, but not sure why that's damning. Keep in mind, not all of the debt is recourse...

 

Despite not giving guidance to PPA renewal values, the company has basically given soft guidance to 2020 earnings. They expected to retire $400M of debt, leaving the company with $638M. At 4x leverage, the company is guiding towards $160M in EBITDA - SGA. Assuming $20M in SGA, thats ~$180M EBITDA.

 

Working off $160M (EBITDA - SGA), assuming $10M Capex, $50M Interest (~8% on $632M debt), that's still $100M in 2020 FCFE, of which $90M is going to common. Not to mention at this point, they'll be investing for growth. Slap on whatever multiple you want, but the bull case certainly has merits.

 

The bull case absolutely has merits, but there is limited downside protection in the event management is wrong with respect to their targets / soft guidance / ability to renew PPAs on favorable terms.  You could value the hydros using PMV for the assets, but I doubt you're getting over 13x ebitda on those.

 

To me this is an investment largely on management and a medium term rise in commodity prices.  Economics of the business will trump managements soundness. 

 

I do see your thesis as one potential likely outcome but I'm having trouble understanding why the risk/reward is assymetrical.