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Northland Power Inc. has accomplished the neat trick of moving from its utility roots into the new world of alternative energy with a series of deals for European wind-power assets – while at the same time providing investors with a healthy dividend.

How has the company managed to generate the cash to do that? There's a compelling argument that the company hasn't.

Northland Power, in announcing its 2014 results last week, said its cash dividends equalled 70 per cent of "free cash flow," down six percentage points from the 2013 figure. If you count the stock payouts made as part of a dividend reinvestment plan, or DRIP, the figure was 95 per cent, also a six-percentage-point decline. CEO John Brace, in his statement accompanying the numbers, said Northland Power is "well-positioned for continued growth … while maintaining the dividend payments and delivering results our shareholders can depend on."

"Free cash flow" has no specific definition under International Financial Reporting Standards, however, and the analysts at the accounting-focused firm Accountability Research say Northland Power's calculations distort the payout ratio – so much so, that a better estimate of the metric would be 225 per cent to 300 per cent. "Northland is currently in the midst of a major transition, and has stretched its balance sheet and cash flow payouts in an attempt to have the best of both worlds," Accountability Research's Michael Ruggirello and Mark Rosen said in an October report.

Free cash flow, to many investors, starts with a company's operating cash flow from its audited financial statements. Capital expenditures are subtracted on the premise that the money spent on the tangible, long-term items that keep a company in business isn't freely available to be distributed to shareholders.

Northland Power has an awful lot of capital expenditures on plants and equipment: $1.8-billion in 2014, to be exact. However, in calculating its free cash flow, Northland Power excludes capital expenditures it says are for "growth" purposes. It uses only management's definition of "maintenance" capital expenditures. And, once that standard is applied, only $2.2-million – with an 'm' – of the $1.8-billion in capex is subtracted to arrive at free cash flow.

The analysts at Accountability Research say that Northland Power, a former income trust, is using something akin to the old "distributable cash" metric. "In our experience, having looked at roughly 75 trusts and former trusts that employed the idea of distributable cash, we can say that ignoring 99.2 per cent of capital expenditures definitely falls on the aggressive side of the equation."

Accountability Research suggests a better "maintenance" capex number would resemble the company's depreciation expense, which tracks the use of assets. The company reported $120.2-million in depreciation in 2014; Accountability Research generously suggests just $96.5-million be added to an adjusted "maintenance capex" number. That adjustment, however, cuts Northland Power's free cash flow by nearly two-thirds – and triples the payout ratios.

Northland Power's calculation of free cash flow, however, deducts interest as well as principal payments on the borrowings for capital projects – something few, if any, peers do, the company says. Since the borrowings require repayment more quickly than Northland Power would depreciate the underlying capital projects, this is an even more conservative approach, chief financial officer Paul Bradley argues. "That to me was the No. 1 offence from the [Accountability Research] report – they failed to recognize that."

"We've been public since 1997," says Mr. Bradley. "I don't mean this to sound arrogant, but I think if our business model was broken, or we had the perils [Accountability Research] points out, it would have bitten us in the behind by now."

The fact remains, however, that by broadly accepted calculations, Northland Power is paying its dividend even as it spends its cash elsewhere: S&P Capital IQ reports that from 2009 to 2014, the company racked up $2.6-billion in negative free cash flow (including interest expenses) while also paying out $534-million in cash dividends.

The company is certainly not the only one in Canada to maintain a healthy dividend while posting negative free cash flow. But, as with the others, it matters less if Northland Power can keep on raising the money. In late January, the company had strong demand for $157.5-million in convertible bonds. On Tuesday, it said it sold $270-million of common stock, including $50-million to founder and chairman James Temerty and his family.

Which means that Northland seems poised to continue its payouts for the foreseeable future – no matter what the cash flow ledger might say.

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