TransAlta Corporation (USA) (NYSE:TAC) is faced with the tough path ahead. By 2030, all of the coal-fired energy plants will be required to retire in the province of Alberta. Some 6GW of those are currently operating in the province with TransAlta’s ownership carrying 3.5GW. Under federal regulation, coal-fired plants have 50 years of useful life and otherwise they would be expected to operate until the end of this timeline. However, based on the plan of the NDP government, out of the 12 plants owned by TAC, four would be forced into an early retirement, creating a considerable pressure on the balance sheet of the company.
The company’s priority this year is to reach a mutually beneficial coal transition arrangement with the Alberta government. In April 2016 the company started discussions with Terry Boston, a government-appointed facilitator to work out a way to reach this objective. In six months the facilitator will provide own recommendations to the government, but the TransAlta plans to meet expectations of the government in maintaining system/grid reliability, provide stable prices for consumers and minimize stranded capital. The company has own points on how to achieve those objectives, and they were summarized by Donald Tremblay, CFO during Q1 2016 conference:
1. Market mechanisms and a market structure that sustain our promises to current investors and attract new capital
2. Meaningful incentives to drive the build-out of renewable and gas-fired generation
3. A clean and thoughtful policy environment for the use of gas-fired generation
4. Market rules that ensure generators are paid for the services they provide to maintain grid reliability.”
What complicates the situation for the company is that electricity prices in Alberta are the lowest in the decade. Moreover, the company is faced with two years of heavy debt repayment looking at the $920M US and $204M CAD in maturity, with principal payments starting in 2017. Although, electricity sales are hedged allowing to deliver profit in Q1 2016, the company has taken the tough decision to reduce the dividend payments by some 78% to improve the cash flow. The $1.5B CAD credit line is available, but current estimates see debt repayments made by a combination of cash flow, expected to provide some $400M, and project level non-recourse debt to cover the balance.
In my view, TransAlta has no choice but to invest in renewables and this creates interesting opportunity for investors in the yieldco of the company, TransAlta Renewables (TNW.TO)
TransAlta currently owns 64 percent of TransAlta Renewables. Its portfolio contains 2.6GW capacity in North America and Australia consisting 1.35GW of the wind, 1.13GW of gas, which includes 150MW being developed in Australia, and some 134MW in hydro. Potential dropdowns to the portfolio account for some 1.3GW including 800MW of Alberta located hydro, 400MW of gas in Canada. The rest, 115MW in the wind and about 21MW in solar are in Canada and the US.
The parent sees the market for contracted gas and renewable assets in Alberta to grow over the next several years with rather a moderate pace, however, because the distributions from TransAlta Renewables secure the cash flow and drop-downs raise cash for the parent, I expect those to continue at relatively accelerated pace. I expect rebalancing of the debt from recourse to non-recourse project financing reach $1B CAD with notable movement from parent’s balance sheet to its yieldco. I suspect to see some announcements around the time of the conference call on August 9th, dedicated to results of the second quarter. Rebalancing of the debt between two companies is certainly allowing the parent to manage own obligations, while private debt issued by Renewables allows for an increase in CAFD generated assets and in the dividend levels.
TransAlta Renewables’ dividend is expected to reach $0.94 CAD in 2017/2018 from some $0.88 in 2016 experiencing 6.8% growth based on the South Hedland project being built in Australia. The yield for the shares is currently at 6.20% which I consider one of the highest in the yieldco family including Pattern Energy Group Inc.(NASDAQ:PEGI), Nextera Energy Partners LP(NYSE:NEP). NRG Yield, Inc. Class C (NYSE:NYLD). On average, at 4.8%, and the target of $0.94 dividends for next year, shares are well positioned to reach $19 and with further improvement in the investment climate for renewable energy yield averaging 4% would bring shares to as much as $22.00 CAD.
RNW.TO is a Canadian currency equity. Therefore this investment offers further potential in appreciation of Canadian dollar against the US currency, in particular, with an increase in the price of the oil. Despite initial forex cost to buy the shares, the fact that Canadian dollar remains still at its four-year lows, investors may find opportunistic to own the shares, while the price of oil returns to more sustainable levels by the end of the year or early 2017.
Edited by odyd