The MoneyLetter recently reviewed security analysts’ reports for three utilities stocks—two independent power producers and a regulated utility.
TransAlta Renewables Inc. (TSX—RNW)
TransAlta Renewables will acquire three assets from TransAlta Corp. (TSX—TA) with a total acquisition price of $439 million for the portfolio, says RBC Capital Markets analyst Nelson Ng.
The $439-million acquisition price includes the remaining $80 million of construction costs for the Windrise wind-farm project in Willow Creek, Alberta, which is expected to be completed in the second half of 2021.
Management expects the annual earnings before interest, taxes, depreciation and amortization (EBITDA) contribution from the assets to be around $45 million, implying a 9.8 times EBITDA valuation multiple, which appears attractive. However, after adjusting for tax equity distributions and excluding the Ada acquisition, Mr. Ng estimates the acquisition multiple for the wind power facilities is roughly 13 times EBITDA, net of distributions, which he says seems more reasonable.
The analyst has increased his 2021 and 2022 comparable EBITDA estimates to $491 million and $507 million, respectively, from $480 million and $494 million, respectively, to reflect the drop-downs and his assumption of lower cash taxes. Mr. Ng’s previous estimate did not include the Ada co-generating facility in Michigan and excluded the BC-based Skookumchuck PTC value from EBITDA. The analyst also expects the Kaybob co-generation facility in Alberta to be dropped down to TransAlta when the project is further advanced.
“We estimate that TransAlta Renewables will have over $200 million of cash after funding the transaction, which could go towards additional opportunities we see in the US and Australia. TransAlta Corp. is also developing a number of wind farms that could benefit from the tax credit extensions,” says the analyst. Mr. Ng is increasing his target share price with a Sector Perform recommendation, which is based on a discounted cash flow approach using a 5.5 per cent discount rate and a $3 per share premium to reflect additional investment opportunities.
TransAlta Renewables is an electric utility company that owns and operates energy generation and transmission facilities.
Fortis Inc. (TSX—FTS; NYSE—FTS)
Fortis’ subsidiary, Tucson Electric Power (TEP), avoided a case decision that could have been materially negative to both earnings and optics. However, RBC Capital Markets analysts Robert Kwan, Matthew McKellar and Maurice Choy say they still came away from the Arizona Corporation Commission (ACC) meeting thinking Canadian utilities stock Fortis may face greater regulatory difficulties in Arizona going forward. The analysts still maintain an Outperform rating on the oft-stable, dividend-earning stock.
The ACC did approve new rates in TEP’s general rate application, which became effective on January 1, 2021. The ACC approved rate base of US$2.7 billion, including approximately US$1.2 billion invested since the last rate order. The ACC also approved an allowed return on equity of 9.15 per cent and equity capital structure of 53 per cent compared to an allowed return on equity and equity capital structure previously of 9.75 per cent and 50 per cent, respectively. The decision includes a 0.20 per cent return on the fair value increment.
TEP has been upgrading its transmission and distribution systems to serve the Tucson area’s expanding population, support economic growth and meet its customers’ evolving energy needs. TEP investments provide safe and reliable service to customers while transitioning to a cleaner, more flexible and resilient energy portfolio.
For Fortis, diversification helps, as all of Arizona is only 25 per cent of Fortis’ segment earnings. Although TEP is the largest of Fortis’ Arizona-based utilities, the overall impact of the decision is moderated by Fortis’ diversification across multiple North American regulatory jurisdictions.
The analysts say: “As such, a challenging regulatory decision or outlook in any single jurisdiction is unlikely to have a particularly material impact on the overall company.”
Fortis is a well-diversified leader in the North American regulated electric and gas utility industry, with 2019 revenue of $8.8 billion and total assets of $56 billion as at September 30, 2020. The corporation’s 9,000 employees serve utility customers in five Canadian provinces, nine US states and three Caribbean countries.
Algonquin Power & Utilities Corp. (TSX—AQN)
Algonquin Power and Utilities announced in late 2020 that it would acquire a 51 per cent interest in four Texas wind power facilities from German multi-national energy company RWE AG (FRA—RWE) for roughly US$300 million. These assets increased Algonquin’s exposure to Texas by 439 megawatts and are backed by 11 years weighted average off-take duration. Algonquin already has a 150-megawatt Senate Wind Farm north of Bryson in the Lone Star state.
Texas wind power assets generate revenue from a mix of financial hedges and swaps, long-term unit-contingent power purchase agreements and market energy settlements.
The hedge and swap agreements impose an obligation to deliver energy even in high-priced periods.
With the cold weather in Texas, Scotiabank analyst Robert Hope saw a number of wind units unable to deliver energy. But Algonquin is still rated a Buy.
This is an edited version of an article that was originally published for subscribers in the March 2021, Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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