TransAlta Corporation

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

TransAlta Corporation is a power generation company primarily focused on providing clean and reliable electricity to customers through a diverse portfolio of assets including hydro, wind, and gas-fired facilities.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

TransAlta’s business revolves around generating electricity and selling it to customers. The company’s business operations can be divided into three main categories: Generation, Energy Transition, and Customers and Marketing.

Revenues Distribution

  • Alberta Power Generation: TransAlta’s traditional generating assets (mostly gas, some coal) in Alberta, make up a substantial portion of revenue. A significant portion of these revenues are regulated by the Alberta government and the Alberta Electricity System Operator (AESO) and hence are predictable in the short term. However in long term they depend on the long-term outlook on the power supply and the economics of alternative assets.
  • Hydroelectric Power Generation: Operations from owned and operated hydropower facilities are another source of revenue that is largely regulated and offers predictable and long-term earnings.
  • Wind Power Generation: Renewable energy generation including solar and wind assets are increasingly significant for the business. However, revenue fluctuations depend on weather conditions, energy prices in different geographic regions, and the subsidies for clean energy.
  • Energy Storage: TransAlta is also developing energy storage assets such as pumped hydro and battery storage. As these assets enter operations, these will provide an additional source of revenue. However, they are extremely new and there is less information available and the market is not yet mature.
  • Energy Marketing: This segment involves selling power contracts to large customers that make up the total profits for the company.
  • U.S. Operations: TransAlta also operates generating and wholesale marketing operations in the U.S., which are also a significant portion of overall revenues.

Industry Trends

The electricity generation industry is going through rapid changes, with increasing focus on transitioning to clean and renewable energy sources. Several macro trends and government policies favor companies in the renewable sector. Also, in the U.S. there are incentives for energy storage.

  • Transition to Renewables: Government policies and consumer preferences in the U.S., Canada and EU are pushing the companies towards renewable energy.
  • Electrification: With the rise of electric vehicles and other green technologies, demand for electricity is expected to be much higher in the future.
  • Decentralization: The rise of distributed energy resources, such as solar panels on individual homes is going to decentralize the energy market.
  • Digitalization: The increasing use of data and artificial intelligence is changing the way energy is produced, transmitted and used.

Margins

Margins for TransAlta’s business are highly variable. They are dependent on several factors, including fuel prices, production volumes and other production related costs. The profit margin for TransAlta is also determined by electricity prices which are often volatile as well as regulatory policies which also add to more unpredictability.

Competitive Landscape TransAlta operates in a competitive landscape with many regional and global players.

  • The largest competitors are vertically integrated energy companies, which possess their own power production and energy delivery infrastructure.
  • There are also independent power producers that compete with TransAlta on price.
  • Also, there is increasing competition from new renewable energy developers, who are able to produce power for cheaper costs due to rapidly developing technologies and efficiency.
  • Finally, some of the state-owned energy providers have an economic advantage as they are supported by the state and have access to lower cost funding.

What Makes TransAlta Different Several factors make TransAlta different from other companies in the market:

  • Legacy Portfolio: TransAlta still has a diversified portfolio of assets including legacy natural gas and coal plants that contribute to a large portion of revenues. However, they are actively replacing them with new renewable and storage assets.
  • Geographic Diversification: The company has power generation assets in Canada and the United States as well as operations in Australia.
  • Strong Integration in Alberta: They have deep connections with the Alberta power grid and are heavily intertwined with their regulations. This gives some predictability but also exposes the company to political risk.

Recent Controversies/Concerns:

  • Rising Fuel Prices: Recently, energy prices have been volatile, which impacts the profitability of the business, especially for the gas-fired plants that are still significant for TransAlta. TransAlta is shifting its focus to a more sustainable production model.
  • Transition Challenges: Shift towards more renewables, including their development, permitting, and connection to existing grids is a huge undertaking, and there can be many obstacles and time delays along the way.
  • Regulatory Uncertainty: TransAlta operates in highly regulated markets; changes in government regulations or policies can impact the company positively or negatively.

Financial Analysis

TransAlta’s financials have shown improvement in revenue, profitability and margins. However, that is due to the rise in power prices. It is not an indicator that its operations are very sustainable as it has not yet reached the goals that were outlined.

  • Revenues: For the full-year 2023, TransAlta reported revenues of CAD 6.81 billion compared to CAD 5.75 billion in 2022, an increase of 18.4% from a year earlier. This indicates that the company has been able to increase its sales price by about 18.4%.
  • EBITDA: EBITDA for 2023 was CAD 1.79 billion compared to CAD 1.64 billion for 2022. The increase is also due to higher power prices. Also, increase in the revenue of their hydro operations has also helped their EBITDA.
  • Net Income: In 2023, TransAlta had a net loss of CAD 474 million (compared to net income of CAD 214 million in 2022). This is primarily due to some of the accounting changes. But that indicates that profits were very susceptible to economic swings.
  • ROIC: Return on Invested Capital was 7.1 percent in 2023, which is a decent performance but nothing compared to other companies in the technology or some financial industries.
  • Capital Expenditures: The business also has heavy requirements for capital to keep the business running, and they have a higher need for capital for future growth as the company transitions from legacy fossil fuel assets to renewables and energy storage.
  • Debt: As of the 2023 report, debt levels are also relatively high, which make the company’s finances more risky.
  • Guidance: For 2024, TransAlta has outlined EBITDA guidance of $1.46 billion to $1.61 billion and free cash flow guidance of $720 to $870 million. Management has also projected capital spending for 2024 to be between $2.9 billion to $3.3 billion. These projections are based on the assumption of continuation of business operations at current levels and do not account for further improvements or changes to the underlying markets. This also shows that the company’s earnings are extremely tied to macroeconomic factors which makes them hard to predict.

Moat Rating: 2 / 5

TransAlta’s moat is very narrow, and based on the current landscape they do not have a strong moat that can last over long periods.

  • Economies of Scale: Although, TransAlta is a major player in the electricity market, economies of scale are largely limited to their local markets. There is very limited regional or national scaling advantages.
  • Switching Costs: There are very minimal switching costs for their customers, they can switch to another supplier with relative ease.
  • Barriers to Entry: There are barriers to entry in the electricity market, as new entrants require access to regulatory approvals, funding and distribution networks. However, competition is increasing from new players in the renewables sector and those are making it harder for existing players to retain market share and high profitability.
  • Economic Moats: Economic moats such as brands or unique technologies are limited and do not offer a sustainable advantage for the company.

Risks to the Moat

  • Technological Disruption: This risk is very high as the electricity sector is seeing a rapid introduction of disruptive technologies that could make TransAlta’s operations obsolete. For example, technological advances in battery storage technology might make pumped-hydro power generation obsolete. Further, improvements in solar, wind, and distributed energy might make the older assets uncompetitive.
  • Regulatory Changes: Governments are pushing the company towards faster transition to renewable and green resources which might create further complexity and burden the existing assets.
  • Competition: The company faces increasing competition from new players in the renewable space, as well as from global power giants.
  • Increased costs: Although inflation does help the revenue as the cost of electricity goes up, increases in costs such as interest rate, fuel for older gas based plant, and other operational expenses will impact the business margins.
  • Business Cyclicality: The profitability and cash flow of companies are always dependent on economic factors and price fluctuations.

Business Resilience:

  • Well-Diversified Portfolio: TransAlta’s diversified portfolio, including traditional gas plants, renewable facilities, and other sources, makes the company more resilient against economic shocks.
  • Geographic Diversification: Operations in several regions provide safety against unexpected events.
  • Contractual Sales: Selling a large portion of their electricity through long term contracts provides revenue predictability.

Understandability: 3 / 5 Although the electricity generation business is straightforward, the complexities of regulations, financing, and emerging markets makes it somewhat complicated to understand.

  • The company has operations and legal agreements in many different markets which adds to complexity.
  • The accounting of power companies is always tricky, there are lots of tax credits, subsidies, special purpose assets etc, that make it difficult to analyze.
  • Finally, this is a utility company that is also trying to transition to new growth areas, which adds a layer of uncertainty and complexity.

Balance Sheet Health: 3 / 5

TransAlta’s balance sheet does not present an ideal picture. Although current assets comfortably cover their short-term liabilities, some concerns emerge from the company’s debt structure and their liquidity profile.

  • The company has substantial amounts of debt that they must continuously service.
  • The cash balances aren’t as high as what would be ideal.
  • Finally, the company is embarking on a major transformation program which will require high amounts of capital. All these factors contribute to a lower balance sheet score.