Morningstar | Increased Confidence TransAlta Will Benefit From Expiring Hydro PPAs; Increasing FVE
TransAlta's earnings are highly leveraged to Alberta power prices, which are volatile due to the small size of the market and supply/demand fundamentals that can change rapidly. Although near-term pricing has recently strengthened due to carbon pricing, our long-term view of Alberta power prices remains pessimistic. Demand remains weak and limits on pipeline capacity to move natural gas out of Alberta has depressed natural gas prices, putting additional pressure on power prices and the earnings power of TransAlta's coal plants, hydroelectric dams, and wind farms.If depressed power prices weren't enough to deal with, management also has to navigate new carbon emission legislation that will phase out all coal-fired power plants in Alberta. TransAlta owns all or a portion of five coal-fired power plants in Alberta with total generation capacity of roughly 3 gigawatts. These plants represented roughly 25% of adjusted earnings in 2018. TransAlta has retired or plans to convert the remaining operating units to natural gas at Sundance. Converting merchant coal plants to gas has not been a successful strategy in the U.S. unregulated power markets and the success of this strategy in Alberta is a concern. TransAlta has made significant investments in Western Australia. These projects are in regions and have counterparties dependent on the iron ore industry, which had seen significant growth. However, with China's steel consumption now in decline, it appears the growth opportunities in Western Australia, once highly touted by management, are now reduced, if available at all.In 2016, TransAlta cut its annual dividend 78% to CAD 0.16 per share. This follows a 38% cut in 2014. We believe the dividend is now secure at the current level due to the November 2016 Off-Coal Agreement that provides annual cash payments to TransAlta to compensate for the closing of three coal-fired power plants in Alberta.TransAlta and its subsidiaries are engaged in the production and sale of electric energy. Co. has 3 segments: the Generation segment which owns and operates hydro, wind, geothermal, biomass, natural gas and coal-fired facilities, and mining operations; the Energy Trading segment which is engaged in the wholesale trading of electricity ; and the Corporate segment which provides finance, tax, treasury, legal, regulatory, environmental, health and safety, sustainable development, corporate communications, government and investor relations, information technology, risk management, human resources, internal audit, and other administrative support to the Generation and Energy Trading groups.
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