3 Reasons Why TransAlta Corporation Is Set to Outperform

In my investing lifetime, I’ve made my share of mistakes. I bought companies without doing proper due diligence. I chased high dividend yields. I even invested in General Motors, pre-bankruptcy. Luckily, I actually managed to make money on that ill-fated position, selling out in 2007 before things really ended up going badly.

I’ve also had some success, or else I probably wouldn’t be doing this anymore. Looking back on it, many of my best investing results were when I followed one simple mantra. I bought shares in companies with high-quality assets that were temporarily beaten up because of operational issues. I did it with several of Canada’s banks over the years, selling only last year because I’m nervous about Canada’s overpriced housing market.

Since hitting a high of over $23 per share in 2010, shares of TransAlta Corporation (TSX: TA)(NYSE: TAC) have been on a steady slope downward. Weak results weighed on the company, as it spent millions in unplanned maintenance on its fleet of older coal-generating power plants. It all culminated early this year when the company announced it was slicing its dividend nearly in half. Shares cratered and are currently sitting at levels not seen since 2000.

Is TransAlta one of those companies that has high-quality assets? I think so. Here’s why I’m seriously looking at picking up shares at these levels.

1. They’re cheap

When companies experience huge operational issues, I tend to look at shares from a book value perspective. Because the market has lost confidence in the company’s ability to generate cash, investors can pick up shares of a company for close to the replacement value of the assets. It seems to me like that would be the best time to buy.

Besides, most investors are short-term thinkers. Why do you think quarterly earnings numbers have such a huge effect on stock prices? Currently, TransAlta trades at just 1.25 times its book value. The last time the company was this cheap was 2004. By the beginning of 2008, shares had nearly doubled, and investors got paid a generous dividend to wait.

This brings me to my second point.

2. Paid to wait

I don’t know when TransAlta’s shares are going to recover, which is why it’s important to get paid to wait.

The company’s shares currently yield 5.8%, paying out $0.72 per year. When I look back at the company’s previous results, I see that it easily earned enough cash from operating activities to cover the new, lower dividend. Although it proved to be an unpopular decision with investors, management made a smart move by cutting the previous dividend.

3. Diversifying away from coal

The main reason why TransAlta’s shares have declined is because of weakness in its coal-fired power plants. New environmental regulations have increased costs, and the company was forced to spent more than $200 million restoring its Sundance plant back to being operational. In the U.S., the company wasn’t able to get favorable contracts for its coal business, so revenue fell.

However, the coal market isn’t so bad. The price of coal has plummeted, which helped the company’s bottom line in 2013 and should do so again in 2014. Plus, the company has actively moved away from coal. It acquired a wind farm in Wyoming and built another in Quebec.

Additionally, now that natural gas prices have cooled somewhat, the future is looking brighter for its natural gas plants. TransAlta just entered into a new 20-year agreement with Ontario for its Ottawa-area plant, as well as a new contract for one of its Australian plants. Currently, just 10% of the company’s generation is susceptible to fluctuating rates.

Things won’t come together for TransAlta overnight. It’ll take years for the company to recover fully, assuming it ever does at all. However, I’m bullish on the company’s long-term future. This looks to be a great entry point for patient investors.

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

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