The renewable industry has been under pressure over the past month. Why? Rising bond yields are negatively impacting industries with high capital expenditures. Yields are rising as the markets are pricing in the threat of inflation which in turn could usher in a period of rising rates.
When interest rates rise, it becomes more expensive for renewables to execute on their growth plans as debt becomes more expensive. For those looking to buy Canadian stocks in the utility sector, this is a concept that you need to understand.
Transalta Renewables (TSE:RNW) has struggled as of late
Market Cap: $5.07 billion
Forward P/E: 25.24
Dividend Growth Streak: 0 years
Payout Ratio (Earnings): 251.09%
Payout Ratio (Free Cash Flows): Premium Members Only
Payout Ratio (Operating Cash Flows): Premium Members Only
1 Yr Div Growth Rate: 0.00%
5 Yr Div Growth Rate: Premium Members Only
Stocktrades Growth Score: Premium Members Only
Stocktrades Dividend Safety Score: Premium Members Only
Since touching a high of $23.99 in early January, TransAlta’s share price has been mired in a downward trend, down by approximately 20% over this period. While this is no doubt disappointing for existing shareholders, perspective is everything.
TransAlta Renewables is still up by 46% over the past year, and 61% over the past three-year period. This correction is healthy for an industry that was white-hot heading into the new year. It may also be an opportunity for investors to either start, or average into new positions.
Trading aside, these short-term fluctuations should not impact the long-term investment thesis of these companies. Sure, rising interest rates will continue to be a headwind, however strong growth can help offset the rising costs.
Transalta Renewables has a nice asset base
The company currently has 44 assets under management which generate 2,537 MWs of energy. Wind and natural gas are by far the biggest contributors, accounting for a combined 73% of cash flow. The assets are fully contracted, and the average contract length is approximately 12 years. This enables it to generate strong and reliable cash flows.
Since 2013 and through the end of 2020, TransAlta Renewables has closed on $3.4 billion worth of acquisitions and in late December, it announced one of its largest deals – the $439 million acquisition of a portfolio of assets from parent company TransAlta. The deal adds 303 MW to installed capacity.
Recently, the company announced its outlook for Fiscal 2021
At the mid-range, the company is looking at an 8% increase in EBITDA and cash flows are expected to be relatively flat.
This isn’t surprising. Unless the company makes new acquisitions, the pipeline of projects currently in development are not expected to enter operation until 2022 or 2023. It has 700MW worth of projects scheduled for completion during this time and another 2,225MW worth of early/mid stage projects in the pipeline.
What does this mean? Don’t expect exponential growth out of TransAlta Renewables this year. Analysts appear to agree as they have a one-year target of $20.73 per share, which implies the stock is close to fully valued at today’s price of $19.14 per share.
Looking forward however, the strong pipeline of projects should lead to excellent growth in 2022 and beyond
While investors wait for growth to kick in, they can take advantage of a strong dividend which currently yields just under 5%. The dividend is well covered by cash flows. What about dividend growth?
TransAlta used to be a Canadian Dividend Aristocrat, but it hasn’t raised the dividend since 2017. Given that cash flows are expected to remain flat in fiscal 2021, investors should not be expecting the dividend to grow any time soon.
Overall, we have a strong company that ran up quite significantly over the past year. The correction was healthy, and from here investors can expect single-digit upside as growth slows in fiscal 2021. Looking further out, TransAlta Renewables has a strong pipeline of projects and that growth should ensure consistent and reliable returns for years to come. Now if you wish, check out this piece we posted covering SNC Lavalin (TSX:SNC).
*Mat Litalien is long RNW