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Algonquin's transformation begins to pay off

In an ideal world of investing, utility firms would generate green power, pay rich dividends and boast rapid growth. In reality, the closest such offering in Canada may be Algonquin Power & Utilities Corp.

The Oakville, Ont.-based company is two years into a five-year plan to double its base of assets, spending aggressively to acquire regional utilities in the United States and to build or acquire independent power generating sites in Canada and the U.S.

Algonquin reported a 55-per-cent rise in revenue, to $204.6-million, for the first nine months of the year. It said profit soared to $31.9-million, from $2.3-million in the year-earlier period. The company also raised its dividend payment twice, giving the shares a yield of 4.6 per cent. In addition, management recently outlined a plan for 8-per-cent annualized dividend growth through 2015.

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The shares are up 21 per cent this year and may see more of a lift following news late Friday that Algonquin has been added to the S&P/TSX composite index.

Some investors will remember Algonquin's shift to a growth utility three years ago with bitterness. Known as Algonquin Power Income Fund at the time, the fund slashed its distribution by 74 per cent and promptly bought out the management contracts. Its shares got hammered in the process.

Today, chief executive officer Ian Robertson says it was implicit in the conversion that the new corporation would replace its high payouts with a mixture of smaller dividends and growth. "We were saying to shareholders, please let us keep those nickels that we would otherwise have given to you as an income trust and they will come back as dimes because we have great growth opportunities," he said.

Since the conversion, the shares have more than rebounded and the company has raised hundreds of millions of dollars in debt and equity to fund its acquisition strategy.

Algonquin operates two primary businesses: power generation and utilities. It generates renewable electricity through hydroelectric and wind power plants across Canada and in the Northeastern U.S. It also operates a thermal division, which generates energy from waste and steam production. The utility division distributes water, gas and electricity.

Over the last year, the company has raised or refinanced more than $550-million worth of debt and equity, extending debt maturities and lowering the risk profile. It aims to complete an additional $300-million of financings in 2012 with plans to invest about $150-million in the acquisition of more U.S. utilities.

The growth strategy has meant diluting the share base. The number of shares outstanding has risen from less than 75 million three years ago, when Algonquin was a trust, to 136 million today. In October, the company made a public offering of nearly 17 million shares at $5.65, raising $95.3-million. Over the next year, another 27 million shares will be issued to Algonquin's largest shareholder, Emera Inc., through several investment and partnership agreements. The Halifax-based energy and services company will see its stake rise from 6.25 per cent today to 22 per cent by the end of 2012.

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Mr. Robertson said the dilution is part of the evolution from an income trust to a more conservatively financed organization. Management's focus is on earnings per share and cash flow per share, rather than total shares outstanding, he added. "We're doubling the business, so we'd expect the equity we are issuing to grow too."

Algonquin's total debt-to-equity ratio soared to almost 150 in the first quarter, but declined to about 100 in the last two quarters, less than where it stood during its final years as an income trust.

Ian Tharp, of CIBC World Markets Inc., thinks Algonquin's overall financial condition has improved and the company could see its BBB- credit rating bumped up, thereby reducing its cost of capital and improving access to funds. Algonquin reported having $15.5-million of cash on hand as of Sept. 31 and $83.4-million of liquidity and capital reserves.

Mr. Tharp rates the shares "sector outperform" and has a 12- to 18-month price target of $6.50 on the stock. He is one of 13 analysts who rate Algonquin a buy, compared with just two hold recommendations.

One of the biggest challenges Algonquin faces is successfully managing the regulatory process for utilities in the U.S. At the moment the company is awaiting approval on deals from authorities in California, New Hampshire, Missouri, Iowa and Illinois.

Algonquin also relies on favourable government policies toward renewable energy, including subsidies. The industry will become less dependent on government largesse as the cost of technologies declines and efficiencies improve, Mr. Robertson said. "Subsidies are getting less important over time. But if governments completely reverse their decisions, it wouldn't be great for industry," he said.

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After closely monitoring the economics of solar power for several years, Algonquin finally took its first step into the solar power market last month, agreeing to buy Cornwall Solar Inc., which owns the rights to develop a 10-megawatt project near Cornwall, Ont. The deal and development will cost about $45-million. Algonquin also purchased an option to acquire 10 other solar projects of the same size.

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