TransAlta Corporation (TSX:TA)(NYSE:TAC) is an Alberta-based power-generation company that’s been hammered over the past five years for all the right reasons. It has had weak revenue due to low regional power prices, weak oil-patch activity flattening demand, and a newly elected provincial government which is intent on phasing out coal power generation by 2030.

The company has slashed its annual dividend from $1.16 per year to less than $0.12 per year to free up cash and invest internally to convert its existing coal plants into gas plants.

At this point, the company is trading so cheaply that a prudent investor could have significant upside at today’s valuation. Not only can the company convert to a stable, dividend-paying utility company, but there are three specific points that can lead to a potential further surge in share price.

First, the company currently holds 62% of TransAlta Renewables (TSX:RNW), a stake worth ~$1.9 billion. This asset is important for two reasons: a) investing in renewable energy has become a hot-button issue, and support has been one of the Trudeau government’s mandates; it is safe to say that both legislative support and funding for this sector will not be cut any time soon; and b) TransAlta Renewables is on track to pay out just under $200 million this year in dividends; these distributions can be channeled back into TransAlta’s free cash flow and its investments.

Second, TransAlta is still maintaining a small dividend worth roughly $100 million each year. It is my speculation that this dividend is currently being maintained to keep some institutional investors interested in maintaining a stake in the company. However, cutting the whole dividend could free up additional cash flow to cover for unexpected expenses and/or help manage the company’s debt.

And third, the Albertan government has just settled with three utility companies (including TransAlta) and will pay $97 million per year until 2030 in return for the early phasing out of six coal plants. This was a heavy uncertainty surrounding the company which has now been solved. As the future of the company becomes more clear, and as the investments come to fruition, the company’s shares will likely trade at a fairer cash flow valuation.

TransAlta’s shares have been punished so heavily over the years that the company can be bought at a bargain-bin price. Foolish investors who can buy stock at a reasonable level could have tremendous upside if the company properly executes its transformation and is able to afford to once again churn out a healthy dividend.

The post TransAlta Corporation: A Turnaround Story Trading at a Bargain Price appeared first on The Motley Fool Canada.

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As oil prices fluctuate near five-year lows, airline stocks, including WestJet Airlines Ltd. (TSX:WJA) and Air Canada (TSX:AC)(TSX:AC.B) have been making headlines amid record profits and margins fueled by the boon of lower costs and an ever-increasing demand for travel. As a result, airlines have invested heavily in increasing capacity and destination offerings to please customers and compete for their share of traffic.

While soaring profits are leading to investor interest, the industry has not fundamentally changed from what Warren Buffett has called “a death trap for investors.” Here are the top three reasons why airlines continue to be risky investments.

Major fixed and uncontrollable expenses

Airlines not only have to invest up front and heavily into equipment, but they often also need to work with expensive unions and are subject to wide fluctuations in fuel prices. All of these factors lead to weak structural economics and fluctuating expenses that either need to be absorbed by the company or passed on to consumers in what I believe is a price-elastic business.

Revenue is a race to the bottom

Price-screening services (SkyScanner, Hopper, Kayak, and Google Flights, just to name a few) have driven heavy price competition in an industry that already has a high reliance on loyalty programs that provide hefty (and expensive) rewards. Cost savings also tend to get passed on to consumers in a bid to remain competitive, which is and will be increasingly difficult with the growing presence of low cost carriers (LCCs).

LCCs remain a significant threat to NA operators as they expand and increase pricing pressure. LCCs had a 26% market share in 2015 (2% below the global average) and could grow to over 30% if the NA market continues the trend.

Relentless competition

Airlines are constantly competing to see who can offer the best flying experience and service for the lowest dollar cost. Upgrades in infrastructure and in-flight entertainment are costs often borne by the company in order to simply remain relevant to consumers; as a result, individual airlines not only have low pricing power (inability to increase prices), but will likely have difficulty innovating to command a price premium to peers.

Conclusion

Airlines are big businesses that, unfortunately, come with big expenses and big uncertainty. While strong brand names, economies of scale, and large start-up costs offer great entry barriers, the competition within the industry remains fierce and unforgiving, resulting in an inability to offer what makes a consumer service stock great: high loyalty and strong pricing power that create long-lasting returns.

The post Why Airlines Continue to Be Risky Despite Lower Oil Prices appeared first on The Motley Fool Canada.

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Royalty funds have a unique advantage vs. common shares in a company: they own a piece of sales instead a piece of profit. The royalty structure allows investors to collect distributions as a percentage of top-line sales regardless of the company’s profitability, creating the excellent opportunity to own a piece of strong brands and growing franchise operations without much of the traditional worries associated with expenses.

Of the public royalty funds, large franchises are among the most lucrative as they tend to have stable, growing top-line figures and have scalable brands and operating procedures. During growth, profits may fluctuate while top-lines sales grow, resulting in steadily increasing distributions. Two companies showing aptitude for this model have been Pizza Pizza Royalty Corp. (TSX:PZA) and A&W Revenue Royalties Income Fund (TSX:AW.UN).

Pizza Pizza Royalty Corp.

Pizza Pizza is one of Canada’s top pizza franchises with leading market share in Ontario (28%) and a strong foothold in western Canada with the acquisition of Pizza 73 in 2007 (16% Alberta share).

Royalty rates are set at 6% of traditional Pizza Pizza Restaurant sales, 5% of non-traditional Pizza Pizza restaurant sales (kiosks, etc.) and 9% of all Pizza 73 sales. Key indicators to watch for are same-store sales growth (SSSG), total stores in the royalty pool, and total stores in the business; Pizza Pizza has consistently grown each of these by leveraging its brand, proven marketing, and SOPs, and its  dividend has grown in tandem.

Source: PPRC AIF 2015

Recent investor concerns consist of the struggle in commodities stifling growth in western Canada; however, chain pizza sales tend to be fairly recession-proof with some chains even experiencing growth during tough economies. Despite this, Pizza 73 has unsurprisingly shown a setback in 1H 2016, but cash flow overall in Pizza Pizza remains strong, stifling any concerns on dividend cuts.

A royalty fund’s value relies largely on distributions and so can be valued using the discounted dividend model (DDM). Assuming next year dividends are held at the current $0.0713 per share per month, a discount rate of 7% and a conservative dividend-growth rate of 2%, we can arrive at a fair share value of $17.11.

A&W Revenue Royalties Income Fund

A&W has remade headlines as SSSG spiked to 5.4% YTD, royalties increased 12.5% YTD, and a second dividend hike was made in this year alone. The company has solid brand equity as the second share leader in the burger industry and claims to differentiate based itself with better quality ingredients and better taste. Just as important is share of traffic, in which A&W takes second place as well.

While taste and quality is subjective, there is no doubting that its strategy and investments have paid off in recent quarters with growing sales rewarding investors generously through dividend hikes. However, just over a year ago, dividend increases were as rare as every four years, so recent growth numbers may have left the market overly bullish.

Once again, fair value for such a company can be derived using the DDM. With some fair assumption, we can arrive at a fair share value of $31.92–a striking discount to the current share price.

Buy or wait?

Restaurant royalties can be a lower-risk investment that can provide a generous yield boost to your portfolio, provided a reasonable price is paid. Smart investors should consider Pizza Pizza today in their yield portfolio given the margin of safety offered to today’s share price. Proceed cautiously with A&W Revenue Royalties Income Fund given their recent price surge based on short-term indicators.

The post How Pizza Pizza Royalty Corp. and A&W Royalties Income Fund Can Pay You 1st appeared first on The Motley Fool Canada.

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