Electricity demand can be exciting to invest in, even when the latest power price is disappointing. A growing business needs more than a good long-term story, though. It needs enough cash to get through the quieter period and fund the work that comes next.
That’s where a modest dividend can be more appealing than it first appears. A company sending out only a small part of its cash has more room to maintain its assets and invest. Shareholders can receive some income while most of their potential return comes from a stronger business.
TransAlta (TSX: TA) increased its annualized dividend by about 8% this year, to $0.28 a share. The yield is small, but the gap between that payment and the company’s recent cash generation gives investors a reason to look beyond the percentage on a stock screen.
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TA
TransAlta produces electricity from a mix of generating assets. Some power is sold under contracts, while other earnings respond more directly to market conditions. That gives it a different profile from a regulated utility earning an approved return on a local network.
When power prices soften, unprotected earnings can fall. Contracts and hedges can provide some support, while reliable operation helps the company make the most of the power it can sell. Keeping plants available is a practical part of turning demand into shareholder cash.
The second quarter showed both sides. TransAlta produced $143 million of free cash flow, or $0.47 a share, under its own cash measure. That was below the previous year’s quarter, but comfortably above the $0.07 quarterly dividend.
Reported operating cash flow was lower, at $62 million, compared with $157 million a year earlier. The two cash figures answer different accounting questions. The reported figure reinforces the need to keep expectations grounded while electricity prices are weak. I like the small dividend as it leaves breathing room during that kind of uneven period.
Inside the business
The payment used roughly 15% of that quarter’s free cash flow per share. That leaves a much larger share for the company’s other priorities. Free cash flow is an adjusted measure here, so it should be read alongside the reported accounts, but the difference is still sizeable.
At a recent closing price of $17.22, the dividend yields about 1.6%. A $10,000 budget buys 580 whole shares for $9,987.60 and would generate $162.40 annually at the current payment. Here’s what that might look like.
| COMPANY | RECENT PRICE | NUMBER OF SHARES | ANNUAL DIVIDEND | ANNUAL TOTAL PAYOUT | FREQUENCY | TOTAL INVESTMENT |
|---|---|---|---|---|---|---|
| TA | $17.22 | 580 | $0.28 | $162.40 | Quarterly | $9,987.60 |
I like that balance for someone who already owns higher-yielding businesses and wants a different source of potential returns. TransAlta doesn’t need to distribute every available dollar to make the shares worthwhile. It needs to use the retained cash well.
A possible new customer
Data centres offer one avenue. TransAlta has a memorandum of understanding with CPP Investments and Brookfield for proposed development at its Keephills site. The framework contemplates an initial project of roughly 230 megawatts (MW), with TransAlta providing the site and power.
That’s an opportunity with identifiable partners and an existing power location. It still needs the agreements, investment decisions, and development work required to become dependable revenue. I wouldn’t price the shares as though the full proposed expansion were already operating.
Weak power prices and project costs are the main risks. I’d take a modest position and give the cash generation more weight than excitement about future computing demand. That makes TransAlta a useful complement within a Canadian stock portfolio, especially when its role is understood from the beginning.
Bottom line
TransAlta appeals to me as a power investment with cash available beyond its dividend. The small payout gives management room to act, and potential new demand gives that flexibility a purpose. If the next developments turn retained cash into well-priced contracts and profitable generation, the shares could reward investors far more than today’s modest dividend suggests.
