Transalta Corp (TA.TO)

This, by default, is a contrarian company that happens to be in the utility space. This is coming back. They’ve had to do some major cost cutting. They’re converting some of their coal plants to natural gas in order to avoid some carbon tax. The beauty of utilities is that they do generate cash flow. The question becomes, how sustainable is that cash flow. Feels you can do better elsewhere.

He likes the sector. He thinks it looks okay. It broke out and came back to do a test. There is some upside.

(Top Pick Apr 6/16, Up 35%) Cheap valuation. They have an agreement with the Alberta government on their coal. Brookfield has been buying up similar assets.

A utility type stock, and is fully priced at this level. It has had an excellent run this year. He questions if the yield is sustainable on a longer-term basis.

Cut their dividend pretty significantly about 1.5 years ago, and there isn’t really a lot of catalysts in the stock. A coal fired power production largely with some CPA’s that are rolling off over time, and then they will ultimately need to replace their fleet with natural gas, renewables or some combination of the 2. With a yield at 2.1%, and without a lot of growth, there are better options elsewhere.

A utility company that he would not own. You own utility companies for slow, steady growth, steady rising dividends so that you can sleep at nights. This has not been that kind of company. Its operations have been troubled. Management has done some questionable things.

Their legacy business was coal which experienced some difficulty, and was on the way to being shut down in Alberta. The issue was, how much will they get for these legacy assets. Also, they wisely decided to set up a renewable subsidiary where they still own a good chunk of it. This has grown quite nicely. Thinks the CEO is doing a decent job.

Reached an agreement with Alberta for transition payments of about $97 million a year from 2017 to 2030. That news was better than expected and he upgraded it to a $7.50 target. It is a little higher than that, but still pretty cheap on a free cash yield. Trading at 15.3 versus its peers at lower levels. Its payout ratio on a free cash flow is 14%. He would prefer one with a bigger yield and one with the drop downs, Transalta Renewables (RNW-T).

Preferreds. The settlement of the energy issue last week has been very favourable. This company is in good shape, because a lot of their existing coal capacity can also convert into natural gas, so as they meet the capacity markets in Alberta that have been created, that is a plus for them. As to preferreds, people own them for 1) income and 2) for the higher position on the balance sheet. It has a 7% yield, but in 2017, that will reset to 3.1% above whatever the 5-year yield is at the time. The rate-reset game that has been going on in the Canadian preferred market since 2008, has been very painful.

(Market Call Minute.) Has had a good run lately, but given that it is a utility you don’t want to be here.

Long half of pairs trade (Top Pick Sept 15/16, Down 6.65%) He still likes it a lot and it did well until a couple of days ago. It is a deeply undervalued utility.

It is not just the stable generator of electricity any more. Alberta has to go through a full resolution of what they are going to do with coal plants. The dividend has been cut to virtually nothing.

There is too much uncertainty about the Alberta policy vis-à-vis stranded assets, and what compensation they will or won’t get. Until that uncertainty is removed, he would be very careful.

*Long* (Pairs trade with a short on TRP-T). TA-T he was buying as long as a couple of days ago and TRP-T shorting the week before. The ownership of TA renewable in TA-T is worth $7.70 of the share price. At this point the rest of TA-T has a negative value. TRP-T is incredibly expensive. They have excessive debt. They are about to cut the toll of their gas pipeline by 40% which is a major part of their revenue.

If you own, he would suggest you lighten up over time. Feels the worst is over. The problem with the company is that power prices in Alberta were weak for some time, and management wasn’t considered to be top of the heap. He would suggest you switch over time to something like Canadian Utilities (CU-T) Fortis (FTS-T) or Emera (EMA-T).