A Dividend Giant I’d Buy Over TransAlta Renewables Stock

High interest rates are pinching the cash flows of utilities and energy companies with high debt. It started with Algonquin Power & Utilities, which slashed dividends by 40%, terminated the acquisition of Kentucky Power, and is now under pressure to sell the renewable power business. All these efforts are to reduce debt. Algonquin is a smaller company. Dividend giant TC Energy has announced plans to spin off its oil pipeline business and sell around $5.2 billion in assets to reduce debt. And TransAlta Renewables (TSX: RNW) is no exception. 

Why I turned bearish on TransAlta Renewables

TransAlta Renewables is a midcap energy stock that builds, acquires, and operates wind, solar, hydro, and natural gas facilities in Canada, America, and Australia. It is a part of TransAlta Group. The renewables company was operating smoothly in a growing economy, paying monthly dividends since 2013. It kept adding to its debt and servicing it comfortably while paying an average dividend yield of 7%. 

Things got tougher when interest rates jumped from 0.25% in February 2022 to 5% in July 2023. The rising interest rate increased the cost of servicing the debt. Higher interest expenses, combined with the expiry of a major contract, and increasing operating expenses due to inflation strained RNW’s cash flows. 

Its wind and water resources generated lower-than-expected power, reducing its distributable cash flow by 13% to $0.45 in the first half. This made it difficult for the company to pay a $0.94 dividend per share for 2023. Almost a month before the second-quarter earnings, TransAlta Renewables agreed to get acquired by its parent TransAlta, which is more resourceful and has a stronger balance sheet. 

TransAlta is buying RNW shares for $13 cash or 1.0337 common shares of TransAlta. If you invested in RNW for its higher yields, you are better off selling the shares at $13, as TransAlta only offers a $0.22 dividend per share (1.69% dividend yield). 

Buy this dividend giant instead of TransAlta Renewables

A higher interest rate could see many small- and mid-cap companies make tough decisions. At such times, it is better to invest in a dividend giant like Enbridge (TSX: ENB). Unlike TransAlta Renewables, Enbridge has lived through recessions and even the 1990s stagflation when the US Fed hiked interest rates above 10%.

And despite such tough market conditions, Enbridge neither spun off nor consolidated nor slashed dividends. It did pause dividend growth, but its growing pipeline infrastructure even overcame that weakness and helped it grow dividends for 27 consecutive years (even during the 2008 Financial crisis, 2015 oil crisis, and 2020 pandemic). 

Many energy companies’ payout ratios increased as they maintained their dividend while their distributable cash flow (DCF) fell. But Enbridge’s payout ratio remains at 60%, within its target ratio of 60-70%. The remaining 40% DCF gives Enbridge a capital buffer to pay dividends during weak phases. 

Enbridge stock is trading at its 52-week low of below $48. If a recession materializes, the stock could fall below $40, and the company might further slow its dividend growth. But its fundamentals show that it can continue paying a dividend per share of $3.55 

What to expect from this dividend giant

Enbridge stock has recovered from several crises and rewarded its shareholders who bought the dip with a strong recovery rally. After falling 34% from its peak during the pandemic, the stock jumped 57% between March 2020 and June 2022. Even in the 2015 oil crisis, Enbridge stock crashed 30% only to recover 30%.

Enbridge slowed its dividend growth after the crisis. When faced with macroeconomic weakness, your priority is to keep your investments safe. I would sell TransAlta Renewables holdings and buy Enbridge stock instead. Enbridge can help recoup any losses from RNW when the market turns bullish.