Atco Ltd

Atco Ltd (TSX: ACO.X) is a Canada-based multiline utility company, which offers services like infrastructure solutions and caters to clients situated across the world. Apart from this, ACO.X is engaged in business activities such as Structures & Logistics, Canadian Utilities and Neltume Ports.

Atco Ltd. has informed to acquire the Pioneer Pipeline from Tidewater Midstream & Infrastructure Ltd. and its partner TransAlta Corporation at a price consideration of CAD 255 million. The above project constitutes 131-km natural gas pipeline, which runs from the Drayton Valley area to the Wabamun area west of Edmonton, Alberta.

Q2FY20 Income Statement Highlights: ACO.X announced its second-quarter results, wherein the company posted revenue of CAD 938 million, as compared to CAD 1,103 million in the previous corresponding period (pcp). The decline was majorly attributable to the demerger of Canadian fossil fuel based electric generation segment and Alberta power line, couple with lower manufacturing activities, partially offset by improved rate base from Alberta utilities. Costs like salaries, wages and benefits, depreciation, energy transmission and transportation stood higher than the previous corresponding quarter, while plant maintenance, property and other taxes, fuel costs etc. remained lower than the previous corresponding quarter. Operating profit stood lower at CAD 226 million, against CAD 260 million in Q2FY19, due to lower revenue. Earnings for the period stood at CAD 89 million, significantly lower than CAD 311 million in pcp, due to an income tax expense of CAD 35 million, as compared to an income tax recovery of CAD 175 million in Q2FY19. A lower net finance cost of CAD 102 million, as compared to CAD 124 million in pcp partially supported the bottom-line.

Q2FY20 Income Statement Highlights (Source: Company Reports)

Risks: The Company's earnings from its foreign operations are exposed to fluctuations in exchange rates. Regulated Utilities are subject to the normal risks faced by regulated companies. These risks include the regulator's approval of customer rates that permit a reasonable opportunity to recover service costs on a timely basis, including a fair return on rate base.

Valuation Methodology: Price to Earnings Based (Illustrative)

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months 

Stock recommendation:  The utility segment is likely to remain stable in the coming quarters, as the sector is categorized under ‘essentials’ and the business is expected to benefit from the improved realization prices. The company’s business model is defensive in nature with a diversified customer base. Approximately 79% of the group’s exposure is to investment-grade customers. The company has the solid financial strength, with a cash position of approximately CAD 1.14 billion and more than CAD 2.5 billion of cost-effective available credit facilities. The current liquidity seems sufficient enough to meet the group’s near-term requirements.  The company has solid fundamentals and reported EBITDA margin above 35% over the last five years and outperformed the industry peers at the same time.  Also, the company’s ROCE is approximately 250bps higher than its Weighted Average Cost of Capital (WACC); this reflects the financial prudence of the management. Further, at the last traded price, the stock was offering a dividend yield of ~4.39%, which is lucrative considering the current interest rate environment. Meanwhile, in the last six months, the stock recovered from its lows and appreciated ~11%. We have valued the stock using the P/E based relative valuation method and have arrived at a double-digit upside (in percentage terms). For the said purposes, we have considered industry (multiline utilities) average on NTM basis. Hence, considering the above-mentioned facts, current price levels, we recommend a ‘Buy’ rating on the stock at the closing market price of CAD 39.64 on October 5, 2020.

ACO.X Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

TransAlta Corporation

TransAlta Corporation (TSX: TA) operates in a portfolio of power generation assets within Canada, the United States and Australia. The Group operates via two segments, namely Generation and Energy Marketing. The Group provides clean, affordable, and reliable power to municipalities, medium and large industries, businesses and utility customers.

Recently, the company along with its partner Tidewater Midstream & Infrastructure Ltd entered into a purchase and sale agreement with ATCO Gas and Pipelines Ltd., wherein the company will sell the Pioneer Pipeline for a purchase price of CAD 255 million. The transaction is subject to customary regulatory approvals which are anticipated by the second quarter of 2021.

Q2FY20 Financial Highlights: TA declared its quarterly results, wherein the company posted revenue of CAD 437 million, as compared to CAD 497 million in the previous corresponding period (pcp). The average spot electricity price in Alberta remained low during the quarter as compared to pcp. Furthermore, a combination of fewer planned outages, strong hydro generation in the Pacific Northwest and demand losses from COVID-19 and low oil prices, resulting in a sluggish demand contributed to the slide. However, higher revenue from the Wind and Solar segment driven by wind resources and Big Level and Antrim operations supported the overall performance. The company reported its gross margin at CAD 286 million, lower than CAD 320 million in Q2FY19, primarily attributable to a lower income, while a decline in the expenses like fuel, carbon compliance and purchased power supported the company’s margin. The company reported operating loss of CAD 19 million, against an operating income of CAD 51 million in pcp, primarily attributable to a lower gross margin, higher depreciation & amortization costs, coupled with an inclusion of the asset impairment cost, partially offset by lower operations, maintenance and administration costs. Net loss stood at CAD 35 million, against net earnings of CAD 26 million in Q2FY19.

Q2FY20 Income Statement Highlights (Source: Company Reports)

Risks: Due to ongoing COVID -19 pandemic, the company may face a supply chain disruption which could increase the input cost. Also, as the businesses are temporarily closed, the group might face counterparty risk where the payment collection can be delayed. Further, delays in the completion of construction projects on account of labor shortage might hinder expected cash flows.

Valuation Methodology: Price to CF Based (Illustrative)

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: The stock of TA appreciated ~18% in the last six months. The business is resilient in nature as it comes under the 'essentials' and is expected to report stable performance and is immune to the economic cycles. The performance of the first half of the business came in-line with the company's estimates. The company has issued stable guidance, wherein the company is expecting a comparable FY20 EBITDA of CAD 925 million to CAD 1,000 million, while free-cash-flow is estimated within CAD 325 million to CAD 375 million. The company strategize on investing across a wide range of businesses like renewable segments such as wind, hydro, solar, battery and thermal, which produce electricity for industrial customers and communities. The group received regulatory approval from the Alberta Utilities Commission for the repowering of Sundance Unit 5 and Keephills Unit 1 into combined-cycle units, during the quarter, which is a key positive. On the project front, Construction for Windcharger, Alberta's first battery storage project, is in its final stages and would achieve its commercial operations date in August 2020. Construction activities on the Windrise Wind Project continue to advance; however, the construction schedule has been modified to reflect a COVID-19-related delay in the delivery of the wind turbine components and the company plans to complete construction and commissioning in the second half of 2021. We have valued the stock using Price to CF based relative valuation method and have arrived at a lower double-digit upside (in percentage terms). For the said purposes, we have considered peers like Capital Power Corp, Northland Power Inc etc. Hence, we recommend a 'Buy' rating on the stock at the closing market price of CAD 8.33 on October 05, 2020.

TA Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

Disclaimer

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