Contrarian investors are constantly searching for unloved stocks that might offer a shot at some decent long-term gains.
Let’s take a look at TransAlta (TSX: TA)(NYSE: TAC) to see if it deserves to be on your buy list.
Rough ride
Ten years ago, TransAlta traded for $37 per share and paid a juicy dividend. Since then, a combination of falling power prices, the oil rout, and negative sentiment toward coal-fired power generation hit the stock hard.
Facing cash flow challenges and high debt, management cut the dividend a number of times and has worked hard to right the ship. At the lowest point, in early 2016, TransAlta slipped below $4 per share. Today, TransAlta trades for $7.60. The recovery has been a slow grind, but recent strength suggests better days might be ahead. In the past two months, TransAlta is up about 15%.
Earnings
TransAlta reported steady results for Q2 2018. The company generated funds from operation of $188 million, pretty much in line with the same period last year. Free cash flow, however, jumped to $96 million from $30 million. For the first six months of 2018, free cash flow was $334 million, putting the company on track to hit the high end of its guidance for the year.
Net debt continues to come down. Since 2015, TransAlta has reduced debt by $1.2 billion.
In the Q2 statement, CEO Dawn Farrell said the company has benefited from better-than-expected cash flow in 2018 due to strong performances from the Alberta hydro assets.
TransAlta transferred two wind projects for $166 million to its TransAlta Renewables subsidiary during the first half of the year. At the end of the quarter, TransAlta owned 61% of TransAlta Renewables.
Outlook
TransAlta continues to worth through its transition away from coal-fired generation. Under a 2016 agreement, TransAlta is receiving more than $37 million per year through 2030 from Alberta as compensation for shutting down or converting its coal-fired plants. TransAlta has already retired or mothballed its Sundance 1, 2, 3, and 5 units at the Sundance power plant.
The company is planning to convert up to seven of its Sundance and Keep Hills coal-fired units to natural gas. Assuming all the approvals are received, TransAlta could have the conversions completed by the end of 2022.
Should you buy?
TransAlta is making steady progress on its turnaround efforts. The balance sheet is in good shape, and the 2016 agreement with Alberta cleared up the uncertainty around the company’s future in the province.
The current quarterly dividend of $0.04 per share should be safe and provides a yield of 2%. As power prices improve, investors could see a return to dividend growth in the coming years.
Some investors see TransAlta as a screaming buy. The company has a market capitalization of $2.2 billion, while its stake in TransAlta Renewables is worth about $1.95 billion.
I wouldn’t expect the stock to double in the next year, but a slow and steady move higher is likely in the cards. If you have some patience, TransAlta looks like an interesting contrarian pick today.
