Why Utilities Should Be at the Top of Your List!

With rates in the rise, investors need to appreciate traditionally shunned companies such as TransAlta Corporation (TSX:TA)(NYSE:TAC).

| More on:
electric power transmission

Licence: https://creativecommons.org/licenses/by/2.0/ Source: https://en.wikipedia.org/wiki/File:Romanian_electric_power_transmission_lines.jpg

When something is loathed by many, it’s sometimes the best opportunity for investors to begin buying, as in many cases, the tide is often set to turn. As the old saying goes, “Buy low and sell high” is being reaffirmed repeatedly. In the case of utility stocks and their attractiveness amidst higher rates of interest, investors now have the opportunity to buy at a very attractive price.

After the most recent rate hike, many utility stocks that are known as highly leveraged entities could pay a high amount of net income (or free cash), as dividends are not the most favoured in the market. The headwinds are now twofold.

First, as interest rates rise, the cost of financing the debt that was incurred in order to build the infrastructure used to generate revenues and the total amount of free cash available to investors will decline in tandem with higher interest rates. In many cases, however, the borrowings are fixed for a period; the reality is that time does move forward and long-term bonds do mature. Eventually, utility companies will have to roll their debts and potentially take on new debt if they want to expand their footprint and grow revenues at more than the rate of inflation.

The second headwind for investors in utility stocks is the comparison between the dividend yield that investors would receive when purchasing shares and the rate offered on long-term bonds. As interest rates have recently increased by yet another quarter point, the rate offered to investors in fixed-income investments is no longer so low that it doesn’t warrant consideration. The dividend yield, which was previously high enough to justify taking on additional risk, may now fall short of what is needed to justify purchasing stocks.

In many cases, the result of this is a decline in share price.

Enter TransAlta Corporation (TSX:TA)(NYSE:TAC), which has traded between $7 and $8.50 over the past year. At its current price of $7 per share, investors will receive a dividend yield of more than 2.25% as the company continues to retain close to 90% of cash flows from operations and trades at a discount to tangible book value as a result.

When subtracting all liabilities and goodwill from the assets, the amount left over is no less than $10.17 on a per share basis. With a 30% discount to tangible assets, one has to wonder what investors are waiting for before snapping up this gem.

For those worried about the dilution of shareholders’ equity, one of the best things about TransAlta Corporation is that the low dividend has made it much easier to keep the total number of shares outstanding in check —  and keep shareholders very happy, too. With what is clearly significant potential, the only question to ask is when the broader market will realize the value of this company.

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 RyanGoldsman owns shares of TRANSALTA CORPORATION.

More on Dividend Stocks

Two seniors float in a pool.
Dividend Stocks

TFSA: How to Earn $1,890 in Annual Tax-Free Income

Plunk these investments into your TFSA to earn passive income and avoid the taxman.

Read more »

Engineers walk through a facility.
Dividend Stocks

1 TSX Stock I Wouldn’t Touch With a 10-Foot Pole

AtkinsRéalis (TSX:ATRL) is one TSX stock I'd never invest in.

Read more »

edit Woman in skates works on laptop
Dividend Stocks

3 No-Brainer Stocks to Buy Under $30

These three stocks all offer a huge deal for investors looking for dividends, as well as growth that will last.

Read more »

You Should Know This
Dividend Stocks

How to Convert a $300 Monthly Investment Into $338 in Monthly Income

If you want a certain amount in monthly passive income, invest a similar amount today and leave the rest to…

Read more »

Increasing yield
Dividend Stocks

3 Income Stocks With Big Yields to Consider in April 2024

If you haven’t yet made your March investments, here are three income stocks to buy the dip and lock in…

Read more »

Senior Man Sitting On Sofa At Home With Pet Labrador Dog
Dividend Stocks

RRSP Investors: Don’t Miss Out on This Contribution Hack!

This hack has so many benefits for you -- not just when you put it in your RRSP but for…

Read more »

A red umbrella stands higher than a crowd of black umbrellas.
Dividend Stocks

Passive Income: 2 Safe Dividend Stocks to Own for the Next 10 Years

Dividend stocks such as Manulife and Fortis can help you generate a stable and recurring passive-income stream.

Read more »

Young woman sat at laptop by a window
Dividend Stocks

3 Dividend Stocks Everyone Should Own for the Long Haul

For investors looking for top-tier dividend stocks to buy and hold for the long term, here are three of my…

Read more »