TransAlta Investor Day: Clear Targets And Good Outlook, Though Valuations Are Mixed

Summary

• TransAlta’s latest results were strong, and earnings guidance for the remainder of the year was increased.
• The utility held its latest investor day and released its multi-year outlook in September 2021.
• The event started with an 11% dividend raise.
• The investor day also outlined clear targets through 2025, which will see TransAlta phase out coal and grow renewables.
• Despite a good outlook, the valuations are mixed and we currently consider the name a hold.

Don White/E+ via Getty Images

Introduction

TransAlta (NYSE:TAC) is an electrical utility with assets in Canada, the United States, and Australia. The company’s portfolio is comprised of coal, natural gas, hydro, wind, and other renewables. In addition to trading on the NYSE, it is listed on the Toronto Stock Exchange and trades under the symbol TA.

The company has performed well so far this year, is looking strong into year-end, and recently held its latest investor day. During the event, management raised the quarterly dividend by 11% and delivered a multi-year outlook through 2025 and beyond. This write-up will review that presentation and attempt to assess the organization’s prospects.

We have owned TransAlta since 2014, with an average purchase price of CAD $8.38. I have also written about the company once before here on Seeking Alpha, in 2019 after Brookfield Renewable Partners (BEP) took a stake in the organization.

Latest Results And Updated 2021 Guidance

Source: TransAlta’s Q2 2021 Earnings Presentation

TransAlta’s second quarter was solid. Free cash flow swelled 52% versus the comparable period last year, rising from CAD $91 million to CAD $138 million. Similar improvements were recorded for EBITDA and FCF per share as well. According to the latest conference call transcript, these results were driven by strong performance in the utility’s energy marketing business and higher electricity prices in Alberta and Washington. In Alberta, for example, the spot electricity prices boomed from CAD $30 per megawatt hour to CAD $105 per megawatt hour year-over-year, according to the Q2-MD&A.

Source: TransAlta’s Q2 2021 Earnings Presentation

Management increased TransAlta’s 2021 guidance due to these strong tailwinds. The comparable EBITDA and free cash flow climbed 13% and 22%, respectively. Alberta’s power price assumptions were revised higher too, from CAD $80 per megawatt hour to CAD $100 per megawatt hour; sustaining CapEx was bumped up slightly as well, however. The corporation’s prospects appear good going into year end and the Q3 earnings are scheduled for November 9.

Investor Day Recap

Following the second quarter, TransAlta released its investor day presentation and long-term outlook in late September. The event started on a positive note with a dividend increase of 11%, from CAD $0.045 to CAD $0.05.

Source: TransAlta’s Sept 28, 2021 Investor Day Presentation

Though the dividend was a good touch to kickstart the investor day, the event’s main message centered around setting ambitious renewable energy targets. By 2025, the organization is seeking 2 GW in renewables growth. The executives expect this renewable growth will require CAD $3 billion in investment CapEx, but generate CAD $250 million in annual EBITDA. As a result of this renewable energy push, the business will be completely off coal by the end of 2025, shutting down its last Canadian coal station in 2022 and retiring its Washington-based Centralia coal station in 2025.

Source: TransAlta’s Sept 28, 2021 Investor Day Presentation

This shift away from coal will significantly alter TransAlta’s installed megawatt mix in Alberta. As the slide above demonstrates, the company’s footprint within Alberta will shrink slightly from 4,181 megawatts to 3,801 megawatts. In percentage terms, the company’s share of coal within their Alberta energy mix will shrink from 64% to 0%, while renewables will expand from 30% to 52%, natural gas will grow from 6% to 45%, and battery storage will be added to account for 3% of the mix. These are significant changes to the business’s operating assets but follow a trend of coal-to-gas conversion that goes back many years to Dawn Farrell’s time as CEO.

Source: TransAlta’s Sept 28, 2021 Investor Day Presentation

Curious readers may be interested to know how TransAlta plans to fund CAD $3 billion for growth while still meeting its other obligations. The answer is that the company expects to draw upon a number of sources, including cash on hand, pro-forma cash flows, project financing, a 2022 bond refinancing, and its equity stake in TransAlta Renewables (OTCPK:TRSWF) (traded under the ticker RNW on the Toronto Stock Exchange). While the c-suite is confident this plan is fully funded, cash flow projections are pro-forma after all, which does represent a risk.

Source: TransAlta’s Sept 28, 2021 Investor Day Presentation

Nevertheless, Alberta’s merchant market appears favourable over the next few years. During this time, the power market should produce high average prices and moderate price volatility. This means that the cash flow projections upon which TransAlta is depending to fund its growth and meet its obligations should be stable and reliable.

Past 2025, the enterprise expects to have an additional 5 GW of renewable energy projects in the pipeline, and to increase its renewable fleet two-fold. Management anticipates these actions will drive a 70% reduction in greenhouse gas emissions by 2030 against a 2005 baseline.

To make a long story short, TransAlta is betting on green energy in a big way. They are doubling down on renewables, investing heavily in natural gas, and will be winding down their last coal assets between now and 2025.

Grading TransAlta’s Investor Day

TransAlta receives high marks for their September 2021 Investor Day, as it included many of the features we like to see from forward-looking corporate presentations. First, the executives grabbed the market’s attention by hiking the dividend 11%. By raising the distribution, they generated headlines, rewarded existing shareholders while potentially drawing in new eyes, and caught analyst attention right off the bat.

From there, they provided numerical and time-bound financial and operating targets through 2025. Many companies provide numerical targets or time-bound goals, but its rare for a company to do both. In our experience, providing both is important, and is far better than issuing vague statements like “we will increase margins over the medium term,” for example. By stating quantitative targets and tying them to specific dates, analysts and investors are given a detailed roadmap by which to gauge and track management’s progress versus their stated objectives.

Finally, top brass detailed how they plan to achieve their operating and financial targets through 2025 with a clearly explained corporate strategy. Even better, the strategy does not represent a significant (or risky) departure from what the utility has done over the past few years. In many ways, TransAlta is simply beefing up and accelerating what they were already doing (i.e., transitioning from coal to gas and renewables). Taken together, TransAlta receives high marks for this investor day presentation. Now, however, the hard part begins, as they must get to work and deliver.

On a side note, I recently published a video (search: Contra's Take: What Makes A Good Investor Day), and used TransAlta as an example. Investors who are interested in hearing more on the topic and on how to refine their research process may find it worth a watch.

Valuations

TransAlta is currently doing well, and the outlook is good. The latest results were strong, the dividend was topped up, and the investor day presentation was impressive. The valuations have also risen appreciably over the past 18 months, however, and in many cases, metrics are now higher than long-term historic averages. As a result, we consider the stock a hold.

Below are a handful of charts (courtesy of Seeking Alpha) to highlight the point:

Source: Seeking Alpha’s historic TTM EV/Sales valuation data for TransAlta.

Source: Seeking Alpha’s historic TTM EV/EBITDA valuation data for TransAlta.

Source: Seeking Alpha’s historic TTM Price/Sales valuation data for TransAlta.

Source: Seeking Alpha’s historic TTM Price/Book valuation data for TransAlta.

Source: Seeking Alpha’s historic TTM Price/Cash Flow valuation data for TransAlta.

As the charts above suggest, the stock does not appear cheap compared to where it has traded over much of the last 10 years – although its solid performance and outlook likely explain (and justify) these higher valuations. That said, we are deep value investors here at Contra, and prefer to buy downright unloved companies; we currently consider it a hold over CAD $10.50.

The organization’s price does look better on an industry-level basis, however. The table below compares it to other publicly traded Canadian utilities with a focus on renewable and clean energy.

Source: Seeking Alpha’s peer comparison valuation table for TransAlta Corp.

The peers being compared here include TransAlta Renewables, Capital Power Corp. (OTCPK:CPXWF), Brookfield Renewable Partners, Algonquin Power & Utilities Corp. (AQN), and Northland Power (OTCPK:NPIFF). Each peer was carefully chosen to provide readers with the most objective apple-to-apples comparison. TransAlta Renewables, for example, was 60.1% owned by TransAlta at the end of Q2.

Moreover, Brookfield Renewable Partners has invested CAD $750 million in TransAlta, and currently owns roughly 13.1% of TransAlta’s stock, according to INK Research. Meanwhile, Capital Power Corp. was selected in this reference group because its primary market is also Alberta, making it in many ways TransAlta’s closest competitor. Finally, Algonquin and Northland Power were included because of their size and similar focus on renewables among publicly traded Canadian utilities.

As analysts and readers can see, TransAlta is cheaper today when compared to these industry players. This suggests to us that while it isn’t a buy over CAD $10.50 (at least in our estimation), there should be plenty of upside left in the stock as it represents better value than its competitors.

Conclusion

TransAlta is currently on a roll. The utility’s latest results were strong, and guidance for the remainder of the year was increased. Moreover, the September 2021 Investor Day saw the dividend jump 11% and provided analysts with a clear multi-year outlook. By 2025, TransAlta will phase out coal entirely, expand its renewable footprint, and add to its natural gas portfolio. Though the investor day looked good and the company appears cheap versus peers, the valuations have appreciated materially over the past 18 months. Therefore, the stock is currently considered a hold.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of TAC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The opinions expressed – imperfect and often subject to change – are not intended nor should be taken as advice or guidance. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.