Company Overview:

TransAlta Corp. (NYSE: TAC) operates as an electricity generation company with 2,420 MW of wind, solar and hydro energy assets. It has a wide geographical coverage with assets in Canada, Australia, and North America. Since 2009, TAC is focused on creating a diversified portfolio with higher investments in low-cost power assets serving customers across regions. The company has one of the largest wind operations in Canada and largest hydro operations in Alberta.

TAC Details

Figure 2: Capacity by Segments

Source: Company Reports

Figure 3: Revenue Contribution by Segments

 Source: Company Reports, Analysis by Kalkine Group

Clean Energy Investment Plan: TransAlta initiated Clean Energy Investment Plan in Q3 FY19 to reduce carbon emission by over 70% by 2022. This can be achieved by converting existing coal-based assets to natural gas and by increasing investments in wind, solar and hydro assets. In connection to this, the company plans to discontinue coal-firing at Sundance and Keephills power generating stations by Dec 2021. TAC has estimated to spend about CAD 1.02 billion in conversion and repowering of facilities and setting-up cogeneration plants. As of September 2020, the company had about CAD 76 million remaining to be spend.

Figure 4: Alberta Thermal plant to run on natural gas by Jan 2022

Source: Company Reports

TAC estimated to complete the conversion of Sundance Unit 6 to gas-firing plant by mid-November 2020. Its Keephills unit 2 and unit 3 has been issued ‘Full Notice to Proceed’ to achieve conversion by 2021. The company to discontinue coal-firing in its Keephills unit 1 and Sundance unit 4 and to become gas-only plant effective January 2022. Repowering at Sundance unit 5 and Keephills unit 1 to become Combined-Cycle Power plants (using both gas and steam turbine to generate electricity) is progressing and expected to complete by Q4 2023.

In-line with its strategy, TAC decided to reclaim its Highvale coal mine and shutdown it by 2021-end. Further, TransAlta secured gas supply arrangement through fuel supply pact with ATCO Gas and Pipelines and NOVA Gas Transmission Ltd.

Strengthening Renewables Portfolio

TAC had earmarked capex of about CAD 437-463 million towards strengthening its renewable assets portfolio in the US and Canada. As of September 2020, it had about CAD 200 million remaining to be spend.

The company signed a 20-year agreement to operate 10MW utility-scale battery storage project and to sell these batteries in Alberta market. The project already reached commercial operation date (COD) in October 2020. In 2019, the company’s The Big Level wind project (90 MW) and The Antrim wind project (29) reached fully operational status. Both these projects have long-term fixed PPAs with corporate customers. The pandemic has impacted commissioning of 207MW wind project in Canada. The project is expected to achieve COD by H2 FY21. The Skookumchuck Wind Project (62MW) in Washington State remain under construction and expected to be achieve COD before the end of 2020.

Figure 5: TACs’ pipeline projects of about 2.5GW renewable assets in various stages of development

Source: Company Reports

3-year Financial Trend

TAC reported almost flat revenues with CAGR of 0.6% over the last three years while free cash flows improved by 32.6% from CAD 328 million in FY17 to CAD 435 million by FY19. Termination of PPAs, expiration of contracts and transition to natural gas impacted the overall growth. Some of its plants were taken out of service and planned outages were initiated on account of transition to natural gas. The company historically reported positive free cash flows reflecting the benefit of diversified portfolio base and reduced capex spend on coal-based activities.

Figure 5: Key Financial Highlights

Source: Company Reports

FY19 Results Highlight

Revenue increased by 4.4% in FY19 over last year mainly led by increase in production at Centralia and higher merchandise pricing in Pacific Northwest (average spot price of US$ 37/ MWh in FY19 vs. US$31/MWh in FY18). Its comparable EBITDA declined to CAD 984 million even after adjusting PPA termination costs, due to expiry of Mississauga contract and lower scheduled payments on Poplar Creek contract. During the year, TAC received several one-off gains from contract termination. It also benefited from lower operations and maintenance costs (O&M) and reduced fuel input costs. Even after excluding such one-offs, net profit reported was significantly higher than 2018 levels.

Brookfield Investment: In May 2019, TAC received commitment from Brookfield Investment for CAD 750 million to pursue Clean Energy Investment Plan. It had received the first tranche of CAD 350 million against 7% unsecured subordinated debentures due 2039. The agreement also provided Brookfield to increase share ownership from open market to not less than 9%. In connection to this, Brookfield nominated two directors at the AGM. In October 2020, TAC received the second tranche of CAD 400 million from Brookfield in exchange for preference shares. TAC utilized the funds to pursue gas transition, setting-up co-generation plants, and investment in renewable energy assets.

Q3 FY20 Update

Electricity generation during the nine months period September 2020 was affected by lower merchant production at Albertra thermal plant, and both units at Centralia were taken out of service. Partly offsetting this, production at wind and solar energy increased due to commercialization of Big Level and Antrim facilities. Revenues were impacted by lower power prices in the Pacific Northwest. The comparable EBITDA improved if PPA prepayment costs were excluded. Due to transition to gas, the company shut down its coal mine and as a result it had written-down coal inventory (CAD 22 million). Due to this TAC reported losses over comparable period.

Figure 6: Quarterly and YTD Average Spot Electricity Prices (in CAD million)

Source: Company Reports             

TAC had adequate liquidity with cash balance of CAD 270 million and CAD 1,343 million available under its two credit facilities. The company has CAD 1.2 billion debt maturing between 2020 and 2022. Nevertheless, liquidity is further supported by ability to raise funds from unencumbered project assets. During October 2020, TAC raised AU$ 800 million senior notes secured through assets of its South Hedland operation. Debt levels remained stable with FY19 level.

Figure 7: Financial Highlights (9 months September 2020 versus 9 months September 2019)

Source: Company Reports

Top 10 Shareholders:  The following table provides an overview of the top 10 shareholders of BSA Limited. RBC Global Asset Management Inc. is the largest shareholder in the company, with the percentage holding of 13.35%.

Figure 8: Top 10 Shareholders

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Metrics: During Q3 FY20, the company reported EBITDA margin of 35.6% as compared to the industry median of 60.5%. Current ratio of the company stood at 1.13x against the industry median of 1.15x. On the leverage front, asset to equity of TAC stood at 5.36x as compared to the industry median of 4.90 indicating sound liquidity position. While debt to equity stood at 1.97x against the industry median of 2.08x.

Figure 9: Key Ratios

Key Metrics (Source: Refinitiv, Thomson Reuters)

Outlook: TAC is on-track to become a clean electricity generation company with coal-to-natural-gas conversion for all Alberta power plants by January 2022 as per an update provided by the board in 3QFY20 earnings release. The company now expects to close its thermal coal plant in Canada four years ahead of its original plan by 2025 i.e. by the end of 2021.

The management is expecting to achieve lower-end range of EBITDA at CAD 925 million in FY20 owing to pricing pressure in Alberta spot market given the pandemic disruptions and lower oil prices. Free cash flows are targeted to the mid-point of guidance (CAD 325-375 million) helped by lower capex outgo. Interest expenses may surge on account of recently raised senior notes (AU $800 million). The company is expecting to spend CAD 182 million on capex. The company is well-positioned to improve margins in the times of price volatility. The management also highlighted the recent strength in forward market prices in $/MWh in 2021 after declines witnessed in 2020.

Figure 10: Company Guidance for FY20 and Market Price Outlook

Source: Company reports

Key Risks: Spot merchant power price in Alberto region has shown signs of volatility recently due to COVID-19 and impact of lower oil prices. As a result, TAC expects FY20 EBITDA to be at lower-end range of its projections. Delay in project transition exceeded beyond timelines may impact the revenues and cash flows.

Figure 11: Key Valuation Metrics

Key Valuation Metrics (Source: Company Reports)

Valuation Methodology: Enterprise Value to Sales Multiple Based Relative Valuation (Illustrative)

Enterprise Value to Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: TAC has provided returns of +8.125% in the past three months, 14.95% in the past 6-months, and is currently trading below to its 52-week high price offering a decent opportunity for accumulation. On the technical analysis front, the stock has a support level of ~US$5.696 and a resistance level of ~US$7.616. We have valued the stock using EV to sales multiple-based illustrative relative valuation method and have arrived at a target price of low double digit-upside. For the purpose, we have taken peers like Orion Energy Systems (NASDAQ: OESX), Advanced Energy Industries Inc. (NASDAQ: AEIS), and SunPower Corp. (NASDAQ: SPWR), etc. Considering the company’s commitment in reducing carbon emission by transition to natural gas and pursuing green energy transformation with renewables projects in pipeline covering the US and Canada, recovering market prices, current trading levels, and decent outlook,  we give a “Buy” recommendation on the stock at the current market price of US$6.92, with -0.14% change in previous close on December 1 2020.

TAC Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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