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TransAlta: Environmental Regulations And Cheap Crude Make For A Perfect Storm

Summary TransAlta’s share price has fallen sharply over the last six months in response to the return of cheap petroleum and the election of pro-environment governments in Alberta and Canada. Planned and unplanned downtime in Q2 prevented the company from taking full advantage of hot temperatures in Canada, resulting in a large earnings miss for the quarter. Looking ahead, the company is faced with the prospect of either converting its existing coal facilities to natural gas or writing off a large amount of relatively young assets. While a large forward yield could catch the eye of dividend investors, the company’s outlook is too negative to be an attractive long investment opportunity at this time. Author’s note: This article refers to a Canadian company and all dollar figures represent Canadian dollars unless otherwise stated. The share price of Canadian electricity generator TransAlta Corporation (NYSE: TAC ) has plummeted in 2015 to date as the prices of natural gas and petroleum have halved and regulatory concerns have mounted in its primary markets. This volatility has only increased over the last week in the wake of Canadian voters bringing the country’s pro-environment Liberal party to power in national elections and a rumored buyout attempt, although the company’s shares have rebounded by 27% over the last four weeks. This article evaluates TransAlta as a potential long investment opportunity in light of this uncertainty. TransAlta at a glance TransAlta owns and operates power plants in Canada, the United States, and Australia. Owning more than $9 million in assets, including more than 5,200 MW of generating capacity in the Canadian province of Alberta alone, the company utilizes a diverse mix of coal, natural gas, wind, and hydro to generate electricity that is then sold to nearby electric utilities via power purchase agreements. TransAlta is heavily reliant on coal despite this diversity, however, owning 4,931 MW of coal-fired capacity, 88% of which is contracted out for an average period of 5.5 years. This capacity has an average age of 17 years, making it relatively young given that coal-fired capacity can remain operational for up to 50 years. Another 1,447 MW of TransAlta’s capacity relies on natural gas, of which 95% is contracted out for an average period of 10.9 years. The company also utilizes 1,271 MW of wind power, 65% of which is contracted for an average of 10 years; and 914 MW of hydro, 96% of which is contracted for an average of 5.3 years. While electricity generation operations provide the majority of the company’s earnings, it also operates an energy trading division that has historically generated roughly $50 million in annual EBITDA. TransAlta has reported steady annual EBITDA growth since FY 2009, including 6% annually since FY 2012. This growth has been made possible primarily due to its heavy exposure to Alberta, which has been home to rapid economic and construction growth in recent years due to its large reserves of unconventional petroleum in the form of oil shale and tar sands. In addition to being substantially more energy intensive than conventional petroleum extraction, Alberta’s unconventional reserves became the subject of heavy demand in the early years of the current decade as rising energy prices made their extraction commercially attractive. This set off a resource boom in the province that in turn led to population growth, demand for new housing, and ultimately higher electricity demand. Unfortunately for TransAlta’s shareholders, electricity generators responded to this demand with a sharp increase in supply. Oversupply in Alberta was the ultimate result, leading to lower electricity prices. FY 2010 and FY 2011 proved to be the high points for the company’s annual revenue and EBITDA results, respectively, although both have also rebounded from their FY 2012 lows. It was on the verge of returning to its pre-glut earnings level in FY 2014 when petroleum prices swooned, making the extraction of Alberta’s unconventional petroleum reserves unattractive. The province’s economy has reversed course and the construction industry has faltered, further increasing its electricity glut and hurting electricity prices. TransAlta has responded to the poor situation in Alberta by diversifying its operations in terms of both geography and fuel mix. It has expanded its capacity in Australia, building 1,000 MW of new natural gas-fired generating capacity and acquiring 136 MW of existing renewable capacity. Recognizing its heavy exposure to the North American coal market, however, with North American coal generating capacity contributing 45% of its Q2 2015 consolidated EBITDA and Canadian coal contributing 39%, the company is also moving forward with an effort to expand its share of Alberta’s generation market from 11% currently to 30% by 2021. Perhaps the most important development, however, is TransAlta’s 2013 decision to form a subsidiary focused on renewable generation, the aptly-named TransAlta Renewables (OTC: TRSWF ). In May, TransAlta dropped down $1 billion in Australian assets to its subsidiary in exchange for $217 million in proceeds, which it used to reduce its debt load, and a post-transaction ownership interest of 76%. The subsidiary’s focus on renewable generation assets provides it with a number of advantages over TransAlta, including attractive financing rates and lengthy contracts as Canada’s government incentivizes the move away from fossil fuels to renewable energy. TransAlta, in turn, intends to use TransAlta Renewable’s distributions (it has a forward yield of 9.3% at the time of writing) to provide it with the cash flow necessary to finance its own debt and future capex. TransAlta Renewable will play an important role in TransAlta’s ability to meet its target of $50 million annual EBITDA growth and 8-10% annual shareholder return moving forward, the latter being something that it hasn’t achieved since FY 2011. Q2 earnings report TransAlta reported Q2 earnings that demonstrated the negative effects of its exposure to the North American coal markets and Alberta’s unconventional petroleum market. Revenue came in at $438 million (see figure), down by 10.8% YoY, as availability at its generating facilities declined from 85.4% to 80.9% over the same period (8,820 GWh generated versus 9,283 GWh YoY). The revenue decline came despite an increase in Alberta’s average electricity price from $42/MWh to $57/MWh due to abnormally hot weather during the quarter and was primarily due to one of its coal facilities experiencing damage-induced unplanned downtime that lasted most of the quarter and another facility undergoing planned downtime at the same time. TransAlta financials (non-adjusted) Q2 2015 Q1 2015 Q4 2014 Q3 2014 Q2 2014 Revenue ($MM) 438.0 593.0 718.0 639.0 491.0 Gross income ($MM) 238.0 356.0 450.0 362.0 279.0 Net income ($MM) -131.0 7.0 148.0 -6.0 -50.0 Diluted EPS ($) -0.47 0.03 0.54 -0.03 -0.18 EBITDA ($MM) 133.0 231.0 359.0 238.0 158.0 Source: Morningstar (2015). Gross profit came in at $238 million, down from $279 million YoY. Surprisingly, given the earnings reports of other North American electricity generators, TransAlta’s cost of revenue fell only slightly over the same period from $212 million to $200 million despite the presence of much lower energy prices in the most recent quarter. As a result, net income fell to -$131 million from -$40 million in the previous year. Some of the decline was attributable to a non-cash adjustment to the fair value of the company’s energy hedges as well as the presence of a higher base tax rate in Alberta. Accounting for these factors resulted in an adjusted net income of -$44 milllion compared with -$12 million YoY. Adjusted EPS fell to -$0.16 from -$0.04, missing the analyst consensus by $0.14. EBITDA also fell, declining from $213 million to $183 million YoY. The company’s emphasis on coal-fired generation hurt, with its coal segment reporting the only YoY decline to EBITDA; the wind segment was flat and the natural gas and hydro segments reported gains, albeit insufficient to offset coal’s performance. Beyond its generation segments, however, TransAlta’s trading segment reported a $22 million YoY decrease due to volatility in the energy markets. Free cash flow increased slightly by $3 million to $23 million over the same period, although the company’s operating cash flow fell from $51 million to -$39 million. Outlook TransAlta took steps to reduce the uncertainty in its outlook during Q2, although several new headwinds have developed that will likely offset the positive impact of these steps. First, the company agreed to pay $56 million to settle market manipulation allegations in Alberta, bringing a multi-year saga to a close. Furthermore, the company’s aforementioned drop-down to TransAlta Renewables was the first stage of a process to reduce its debt load via further drop-downs. Moody’s recently announced that it is reviewing the company’s bond rating for a downgrade to junk status in light of its high debt load. In July, TransAlta agreed to purchase 71 MW of renewable capacity in the U.S., and this, too, could become part of a second drop-down to TransAlta Renewables that the company intends to use the proceeds from to further reduce its debt. The presence of very warm temperatures in Canada caused the company’s number of cooling degree-days to increase in Q3, allowing management to reaffirm its previous FY 2015 EBITDA guidance during the earnings call , albeit at the lower end of the given range, despite the Q2 earning miss. The current year’s guidance is likely to receive further support by the development of a historically strong El Nino event, which is expected to keep temperatures higher than normal through September, potentially boosting air conditioner use and supporting electricity prices. These positive impacts could become negative in FY 2016, however. Past El Nino events have been associated with below-average winter precipitation levels, especially in Canada’s western half. Many regions of Canada are already suffering from drought and, given the large number of hydroelectric facilities that TransAlta operates in many of those same regions, it is feasible that an especially strong El Nino could ultimately result in lower availability starting in Q2 2016. TransAlta’s outlook worsens still further beyond 2016. May saw the election of a left-of-center provincial government in the historically conservative Alberta. More recently the centrist Liberal party, which favors restrictions on greenhouse gas emissions, won Canada’s national election and will replace the outgoing pro-business Conservative party. The new governing party is expected to support clean energy initiatives, in part by placing national restrictions on coal-fired generation facilities. Given an average contract term of 5.5 years, TransAlta’s coal segment will need to establish new power purchase agreements relatively soon after any new environmental policies become entrenched. Two of its alternatives, the use of carbon capture and sequestration at its coal-fired facilities and conversion to natural gas from coal, offer ways around this hurdle while incurring additional costs. Carbon capture and sequestration, in particular, is unlikely given the high costs that it incurs despite years of industrial R&D. Conversion to natural gas is more important and while this will incur conversion costs, it is preferable to simply shutting down coal-fired assets that have up to 30 years of effective productivity remaining. A more pressing matter is the continued presence of low petroleum prices in North America. The health of Alberta’s economy has long been linked to petroleum prices, with the province experiencing lower growth and falling construction rates during previous petroleum bear markets in the early 1980s and again in 2009. Likewise, TransAlta’s share price lost most of its value in late 2008 and early 2009 as petroleum prices fell, although crude’s rapid rebound prevented this from being reflected by a steep drop to its annual earnings in either year. The duration of the current low price environment is very important to TransAlta’s outlook due to its current debt situation. The company has $1.1 billion (mostly denominated in U.S. dollars) of debt that matures in FY 2017 and FY 2018, with another $400 million maturing in FY 2019. Its ability to repay these loans while also financing its planned capex and potential acquisitions will be very dependent on the economic health of Alberta, especially given the company’s plans to increase its share of the province’s generation market. While I do not expect petroleum prices to remain at their current levels for such an extended period of time, potential investors should be aware of the potentially severe financial repercussions to the company that would result from such a situation. Valuation The consensus analyst estimates for TransAlta’s FY 2015 and FY 2016 earnings have been revised significantly lower over the last 90 days in response to its missed Q2 earnings report and mounting headwinds, management’s reaffirmed guidance notwithstanding. The FY 2015 diluted EPS estimate has fallen from $0.23 to $0.12 while the FY 2016 estimate has fallen from $$0.29 to $0.23. Both of these results would be well below the company’s 5-year highs. Based on a share price at the time of writing of $5.25, the company’s shares are trading at an adjusted trailing P/E ratio of 105x and forward ratios of 43.8x and 22.8x, respectively. Even the FY 2016 ratio is well above the company’s respective historical range, suggesting that the company’s shares remain very overvalued despite their poor performance in FY 2015 to date. While a recent anonymous report suggested that TransAlta had been very close to selling itself , buying at the current price level would require the presence of very optimistic assumptions regarding future operating conditions for the company. Conclusion Shares of Canadian electric generator TransAlta have lost nearly half of their value over the last six months and are currently trading at only a fraction of their historical high price. While such a negative market reaction often indicates the presence of a value investment opportunity, potential investors in the company should be wary of the numerous pitfalls that sit in its path over the next several years. Low petroleum prices are already causing Alberta’s economy and construction market to slow, hindering the company’s plans to further increase its share of its largest market. Likewise, the removal of the Conservatives from both Alberta’s government as well as Canada’s national government since May make it likely that the company’s heavy exposure to the coal-fired power segment will hamper its overall earnings in the coming years as existing restrictions on greenhouse gas emissions are strengthened and future ones are enacted. With a share valuation that is much larger than its foreseeable earnings potential, a large debt load, and free cash flow per share that has been less than half of the company’s dividend per share in recent quarters, TransAlta is a very risky prospect for investors. There is a chance that a buyout could occur on favorable terms, resulting in a modest gain for new investors. I consider the probability of this occurring to be quite small compared to the potential for further losses in light of how overvalued the company’s shares are at the time of writing, however. Yield-seeking investors are encouraged to look elsewhere.

Robotics Fund Faceoff: ROBO Vs. TDPNX

Summary Automation and robotics are poised to breakout from factories and drive growth in a multitude of industries. Many pure play companies in the field are small or listed overseas, making a fund approach attractive. With lower costs and a more diversified portfolio, ROBO has the edge in this nascent investment arena. Advances in technology as well as economic and social factors are making automation and robotics more feasible for a growing number of companies in a wide assortment of industries. Self-driving cars, drone package deliveries, 3D printing and robot-assisted surgery were once the purview of science fiction. Today, these scenarios are becoming a reality. While industrial automation has been commonplace for decades in developed economies, reduced costs are now making it a viable option in the developing world as well. Once used to replace dangerous, dirty and labor-intensive jobs, automation and robots are being integrated into more aspects of an increasing number of jobs due to advances in tracking sensors, machine controls, nanotechnology and programming. In addition to industrial applications, automation and robotics are also used to deliver needed social services and help people live independent lives. Social, economic and technological trends are pushing advances in the development and integration of automation and robotics. While still in its infancy, the automation and robotics sector offers long-term investment potential. One way to invest in this burgeoning sector is the Robo-Stox Global Robotics And Automation Index ETF (NASDAQ: ROBO ). Another option is the 3D Printing, Robotics and Technology Fund Inv which has two classes of shares. The fund’s institutional class shares trade under the ticker symbol TDPIX while the investor class utilizes the ticker symbol TDPNX . Robo-Stox Global Robotics and Automation Exchange Traded Fund ROBO is a Science and Technology Fund that seeks to replicate the price and yield performance, before fees and expenses, of the ROBO-STOX Global Robotics and Automation Index. The ETF normally invests at least 80 percent of assets in securities contained within the index, which is formulated to measure the performance of companies primarily engaged in or supporting robotics and automation. Securities within the index have a market capitalization in excess of $200 million and a 1-year trailing daily trading average volume of $200,000. The index is divided into four basic categories. This include industrial robots, service robots for government and corporate use, personal- and private-use robotics and firms engaged in supporting robotics and automation. The weight of each category may vary. Managers determine which stocks are deemed bellwether due to their ability to indicate or lead trends for the market segment. The fund maintains a 40 percent weighting in these bellwether securities and 60 percent in non-bellwether shares. The non-diversified ETF utilizes a passive investment philosophy. Of the $100 million in assets in the fund, 38 percent are invested in and 62 percent is invested in foreign issues. In addition to the U.S. and Japan, the ETF has exposure to Developed Europe and Developed Asia. The fund is heavily weighted toward industrial, information technology and healthcare sectors. With an average market cap of $2.7 billion, the fund has 9.9 percent exposure to giant cap companies as well as an 11 percent and 45 percent exposure to large and mid-cap stocks. The fund also holds 17.41 percent and 16.56 percent allocations in small- and micro-cap shares respectively. As of October 15, ROBO had a P/E ratio of 18.05 and a price-to-book of 1.74. The largest holding in ROBO has only 2 percent of assets, making for a well-diversified portfolio. Many holdings in the fund are familiar names that may not make one think of automation, such as Deere (NYSE: DE ), but thanks to the fund’s small allocation in each holding, there’s a lot of pure play exposure to companies such as Mobileye (NYSE: MBLY ), a company working on driverless vehicles. 3D Printing, Robotics and Technology Fund TDPNX seeks long-term capital appreciation by investing at least 80 percent of assets in securities issued by domestic and foreign companies in developed as well as emerging markets engaged in 3D printing, robotics and automation regardless of their market cap. Fund advisers use a top down approach to determine potential candidates for inclusion in the portfolio. A bottom up approach is then utilized to select the stocks for actual investment within the portfolio focusing on factors like company fundamentals and growth prospects within the industry. TDPNX changed its mandate and name in July 2015 due to losses in 3D printing shares, which it was its exclusive focus until then. The fund’s new name and portfolio reflect its branching out into robotics as the 3D printing stocks dipped into a bear market. The new focus is designed to capitalize on the growth in both of these fast growing segments, while avoiding concentration in the narrow slice of the economy. The fund holds 47 percent of assets in domestic stocks and 44 percent in foreign shares. In addition to the U.S., TDPNX has significant exposure to Developed Europe and Greater Asia, primarily Japan. The portfolio has a 16 percent weighting in giant cap stocks as well as 17, 21, 22 and 24 percent weightings in large-, medium-, small- and micro-cap stocks respectively. The fund’s average market cap is $4 billion. The portfolio has a P/E ratio of 25.3 and a price-to-book of 2.21. Fund Comparison ROBO has outperformed TDPNX since the inception of the latter in April 2014. TDPIX has declined 23 percent over its life, while ROBO is down approximately 11 percent over the same period. Since changing its mandate in July, TDPNX has outperformed ROBO, losing 6.5 percent versus ROBO’s 11 percent decline-but it’s much too short a period to draw a conclusion from. ROBO is a fund that delivers on its name. The fund’s extensive holdings include companies involved in robotics, from traditional companies within the industry to those new in emerging sectors, such as unmanned vehicles and medical fields. The top holding in ROBO has barely more than 2 percent of the fund’s assets, and the top 10 have less than 22 percent of total assets. The top 10 in TDPNX accounted for 47 percent of assets as of June 30. TDPNX is a broad fund but makes more concentrated investments. The 3D Printing Fund has only 46 holdings compared to the 82 separate investments within the ROBO portfolio. TDPNX also counts large caps such as Hewlett-Packard (NYSE: HPQ ) and General Electric (NYSE: GE ) among its top ten, diluting some of the pure play exposure (the fund reports it has 46 percent pure play exposure ), but this explains why the fund outperformed ROBO over the past three volatile months. (click to enlarge) TDPNX is the more expensive fund. The Institutional Class has a net expense ratio of 1.25 percent while the investor class’ net expense ratio is 1.50 percent. The fund’s adviser has contractually agreed to waive management fees and/or reimburse expenses through April 15, 2016. Shares are subject to a fee of 2 percent when redeemed within 60 days of purchase. ROBO charges 0.95 percent and is subject to brokerage trading fees like most other ETFs. Conclusion The long-term prospects for automation are better than ever as automated software and hardware are ready to move off the factory floor and into the home, office and highways. Investors who take an aggressive approach can achieve broad exposure with the aforementioned funds. The mandate shift by TDPNX is a good one and makes for a more conservative fund, but this niche segment of the economy will be highly volatile even with some exposure to a Dow component such as GE. ROBO is therefore the more attractive fund for now, in addition to being cheaper and offering broader exposure, but the ETF suffers from low volume. The risk isn’t so much in getting in, but in getting out in the event investors rush to the exits. We saw ETFs suffer flash crashes in August and ROBO was among them. Investors can make ROBO a small niche holding in a diversified portfolio, but be prepared for rollercoaster rides during periods of high market volatility.

3 Southeast Asian Country ETFs Surging In October

The economic slowdown in China may be appalling for the Southeast Asian economies, but there is a flip side to it that actually spells opportunity. Years ago, leading manufacturing companies across the world had turned to China as a production base in order to take advantage of low-cost facilities and inexpensive labor. However, the trend seems to be changing at a fast pace due to the economic turmoil in the world’s second largest economy (read: Asia-Pacific ETFs to Watch on a Surprise Rebound ). Due to the massive growth that China has experienced in the past, its wages and manufacturing costs have grown sharply. Further, the country’s huge population base and rising disposable income of middle class have slowly turned the economy from production-based to consumer-based. It is for these reasons that international companies are becoming more inclined toward taking their labor-intensive manufacturing projects to Southeast Asian nations due to lower labor costs and their ability to handle sophisticated production on a large scale. With this, the companies will be able to cater to an increasing consumer base in China as well as to conventional markets such as Europe and the U.S. The industrial relocation is expected to result in huge foreign direct investment (“FDI”) inflow into these emerging economies. Asian Development Bank expects Southeast Asia to record a GDP growth of 4.6% in 2015 and 5.1% in 2016. This compares with a GDP growth of 2.7% in 2015 and 2.8% in 2016 for the U.S., and 1.5% in 2015 and 1.8% in 2016 for the Eurozone, per forecast of World Bank . Based on these strong economic fundamentals and recent developments, we turn our focus to three Southeast Asian country ETFs that have experienced double-digit gains since the beginning of this month (read: 4 Safe Ways to Invest in Emerging Market ETFs ). iShares MSCI Indonesia ETF (NYSEARCA: EIDO ) Indonesia is struggling with weakening demand from China and low prices of commodities such as palm oil and coal. However, a set of stimulus packages announced by its President Joko Widodo recently is expected to spur growth in this largest Southeast Asian economy. The stimulus measures range from cutting energy prices for companies and giving insurance to farmers against crop failures to giving access to subsidized loans to salaried workers for small business enterprises. Before this, the government has already tried to revive the economy by easing permit processing and stabilizing a weak rupiah. The government aims to achieve a GDP growth of 7% in 2017 through enhanced infrastructure spending and accelerated FDI inflow compared to its six-year low GDP growth of 4.7% for the first quarter of the year. EIDO tracks the MSCI Indonesia Investable Market Index, measuring the performance of Indonesian-listed equity securities in the top 99% by market capitalization. The fund is heavily biased towards financials, accounting for nearly 40% of its assets. It has gathered about $298 million in assets and trades in an average volume of 687,000 shares. The ETF charges 62 bps in investor fees per year and was up more than 25% since the beginning of this month (till October 13, 2015). It carries a Zacks ETF Rank #3 (Hold) with a High risk outlook. Notably, two other Indonesian ETFs also recorded double-digit gains (more than 20%) in the same time frame. They include the Market Vectors Indonesia Index ETF (NYSEARCA: IDX ) and the Market Vectors Indonesia Small Cap ETF (NYSEARCA: IDXJ ) . iShares MSCI Malaysia ETF (NYSEARCA: EWM ) Malaysia is another Southeast Asian economy falling prey to the commodity rout and slowdown in China (its largest trading partner). However, the recent trading data from the country spurred investors’ interest. According to data released by the Ministry of International Trade and Industry, the country’s trade surplus increased to 10.2 billion ringgit ($2.4 billion) in August from 2.4 billion ringgit ($0.6 billion) a month earlier. Exports rose 4.1% year over year while imports fell 6.1% from the year-ago level. Despite the China slowdown, exports to the country soared 32.4% year over year. Meanwhile, exports to the U.S. and the European Union escalated 12% and 13.5% year over year, respectively. The surge in exports can be attributed to its weakening currency. According to Datuk Seri Abdul Wahid Omar , Minister in the Prime Minister’s Department, Malaysia has compensated the loss in oil and gas revenues from the slumping crude oil prices to some extent by implementing the Good and Services Tax in April. Further, its debt level (currently 54% of GDP) is expected to decline given the rising investments from the private sector. EWM follows the MSCI Malaysia Index, which is highly focused on the country’s financials, industrials and consumer staples sectors. The fund has garnered roughly $320 million in assets and trades in a hefty volume of 1.7 million shares per day. It charges 49 bps in annual fees and was up 19.1% so far this month. The fund carries a Zacks ETF Rank #3 with a Medium risk outlook Market Vectors Vietnam ETF (NYSEARCA: VNM ) Vietnam’s economy has been benefiting from low energy costs and very low inflation. Last month, inflation dipped to zero for the first time ever, as per General Statistics Office. Inexpensive labor and devaluation of the Vietnamese dong for the third time in a year by the country’s central bank have also been boosting the country’s exports and attracting foreign investments. The recently enacted Trans-Pacific Partnership (TPP) deal is further expected to boost export demand for Vietnamese goods. Bloomberg data showed that the country’s exports went up 9.6% year over year to $120.7 billion in the first nine months of the year. In the same period, pledged foreign investment soared 53.4% while disbursed foreign investment rose 8.4% from the year-ago levels. According to Asian Development Bank, Vietnam is likely to record the fastest growth in 2015 among the five major Southeast Asian countries tracked by the bank. The growth would be driven by burgeoning private spending, rising exports and increasing flow of FDI. VNM tracks the Market Vectors Vietnam Index, measuring the performance of stocks listed in the Vietnamese stock index, which generates at least 50% of its revenues from within the local economy. The ETF’s holdings are mostly from the financial sector (44%). The fund has amassed nearly $467 million in assets and trades in a volume of 457,000 shares per day. It charges 76 bps in fees and has returned about 13.3% since the beginning of October. The fund carries a Zacks ETF Rank #4 (Sell) with a High risk outlook. Link to the original post on Zacks.com