Is TransAlta Corporation’s 6.6% Dividend Sustainable?

Why TransAlta Corporation’s (TSX:TA)(NYSE:TAC) 6.6% yield might be too good to be true.

| More on:
The Motley Fool

Since the beginning of 2010, it’s been a pretty terrible period to be a shareholder in TransAlta Corporation (TSX: TA)(NYSE: TAC), one of Canada’s largest power generators. Thanks to weakness in power rates, expensive unplanned maintenance, and a dividend cut in January, shares have sunk all the way from $23 to today’s price of $11. That’s not good.

Because of the massive sell-off, TransAlta shares have a very enticing yield of 6.6%, attracting all sorts of income investors. But as we all know, chasing yield can go very badly. Is a dividend cut in the cards for TransAlta? Let’s take a closer look at the company.

Earning power

Lately, the company has had to deal with two issues — weak power prices in Alberta and increased maintenance costs on aging coal power plants.

Alberta doesn’t have regulated rates like most other jurisdictions, which can work out well for power generators, especially during periods between 2004-2008, when demand from the oil sands helped drive up electricity rates for everyone in the province. But lately, things haven’t been so good.

Now that other projects have brought additional capacity to market, prices have suffered. Combine that with several outages because of unplanned repairs over the last few years, and TransAlta has suffered.

Going forward, things should improve. Major capital projects have been completed, and management indicates that capital spending will be less in coming years. Essentially, all the heavy lifting is done, even if the company’s assets are beginning to show their age. These decreases should pave the way to at least maintain the dividend.

One look at the company’s results in 2014 indicates that, at least for now, the dividend is safe. Through the end of the second quarter, it had a free cash flow of approximately $140 million, and paid out just $100 million in dividends. That’s partially helped by investors taking their dividends in the form of additional shares, which offers a 3% bonus to do so. Still, at this point, the dividend looks to be sustainable.

Of course, investors have to exercise a little bit of caution before trusting that the company can sustain the dividend. TransAlta has disappointed the market for so long that folks have the right to be skeptical.

The future of the company

The dividend is just one part of investing in TransAlta. How does it look from a fundamental point of view?

Based on the value of its assets, the stock is exceptionally cheap. Shares trade at just a little more than book value, cheaper than the company has traded at any point over the last decade. If you believe that the major repairs are finally done, shares could recover as earnings potential improves.

But can investors actually believe that? I could have easily made a similar argument in 2012 or 2013, and the company didn’t recover. What makes 2014 any different? Sure, there’s more of a margin of safety if you buy at book value compared to two times book, but ultimately TransAlta needs to get to the point where it has predictable earnings again for it to trade at a higher level. Only then will it move higher. And based on the age of its assets, I can see why the market is skeptical.

Plus, governments, consumers, and investors are at the point where they barely tolerate burning coal to generate electricity. If the technology existed to replace coal with solar or wind power at a reasonable cost, most people would be behind it. It’s perceived as a dirty fuel, so investors stay away. The same phenomenon has plagued cigarette companies off and on for decades. TransAlta could eventually shrug that off, but for now the company has to deal with it.

The bottom line? The dividend looks to be safe — for now. The stock also looks to be cheap on a price to book value metric, but there’s an awful lot of sentiment going against it. There are better choices out there.

We’ve got three terrific dividend stocks you need to see. Check out the report below.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nelson Smith has no position in any stocks mentioned.

More on Energy Stocks

oil tank at night
Energy Stocks

3 Energy Stocks Already Worth Your While

Are you worried about the future of energy stocks? Leave your worries in the past with these three energy stocks…

Read more »

Canadian energy stocks are rising with oil prices
Energy Stocks

What to Watch When This Dividend Powerhouse Shares Its Latest Earnings

Methanex stock (TSX:MX) had a rough year, which ended on a bit of a high note, though revenue was down.…

Read more »

energy industry
Energy Stocks

Canadian Investors: 2 TSX Energy Stocks to Buy for Passive Income

Energy is one of the heaviest sectors in Canada and has some of the most generous and trusted dividend payers…

Read more »

Gas pipelines
Energy Stocks

TSX Energy in April 2024: The Best Stocks to Buy Right Now

Energy prices have soared higher than expected. That is a big plus for Canadian energy stocks. Here are three great…

Read more »

crypto, chart, stocks
Energy Stocks

If You Had Invested $10,000 in Enbridge Stock in 2018, This Is How Much You Would Have Today

Enbridge's big dividend yield isn't free money. Here's why.

Read more »

edit Businessman using calculator next to laptop
Energy Stocks

If You’d Invested $5,000 in Brookfield Renewable Partners Stock in 2023, This Is How Much You Would Have Today

Here's how a $5,000 lump-sum investment in BEP.UN would have worked out from 2023 to present.

Read more »

Pipeline
Energy Stocks

Here Is Why Enbridge Is a No-Brainer Dividend Stock

For investors looking for a no-brainer dividend stock worth holding for the long term, here's why Enbridge (TSX:ENB) should be…

Read more »

Money growing in soil , Business success concept.
Energy Stocks

3 Canadian Energy Stocks Set for a Wave of Rising Dividends

Canadian energy companies are rewarding shareholders as they focus on sustainable financial performance.

Read more »