Oversupplied Energy Markets And Regulatory Hurdles Will Depress Valuations

Key Takeaways

• Regulatory and policy instability, plus oversupplied markets, pose significant risks to earnings stability and revenue from core assets.
  
• Heavy dependence on legacy assets and increased competition in renewables threaten project returns, revenue growth, and balance sheet strength.
  
• Transition to renewables, increased contracted revenues, and strategic partnerships position TransAlta for stable, long-term growth and improved earnings resilience amid rising electricity demand.

Catalysts

Engages in the development, production, and sale of electric energy.

• Significant ongoing regulatory and political uncertainty, including shifting carbon pricing regimes and complex federal and provincial policies, could drive up compliance costs and make long-term planning difficult, directly pressuring net margins and introducing risk to earnings stability.
  
• Prolonged and intensifying oversupply conditions in key markets such as Alberta, exacerbated by increased distributed generation and rapid buildout of small-scale renewables, could compress realized power prices and lower overall revenues from TransAlta's core fleet for years to come.
  
• Heavy reliance on legacy natural gas and formerly coal-fired assets, despite ongoing transition efforts, heightens the risk of asset stranding or writedowns in a future with faster than expected decarbonization mandates, causing a negative impact on net earnings and balance sheet strength.
  
• Rising competition from global utilities and energy majors aggressively expanding into North American renewables may drive down achievable contract prices for new wind, solar, and battery projects, resulting in weaker revenue growth and lower EBITDA margins for TransAlta as its project pipeline advances.
  
• Persistent inflation and higher long-term interest rates threaten to increase the cost of capital and further erode project-level returns for large-scale clean energy investments, limiting the company's ability to compound cash flows and constraining earnings growth despite apparent pipeline opportunities.

TransAlta Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on TransAlta compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming TransAlta's revenue will decrease by 7.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 0.0% today to 2.8% in 3 years time.
• The bearish analysts expect earnings to reach CA$59.6 million (and earnings per share of CA$0.22) by about July 2028, up from CA$1.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 82.0x on those 2028 earnings, down from 5069.3x today. This future PE is greater than the current PE for the US Renewable Energy industry at 17.4x.
• Analysts expect the number of shares outstanding to decline by 0.7% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.69%, as per the Simply Wall St company report.

TransAlta Future Earnings Per Share Growth

Risks

• Growing long-term demand for electricity-driven by population growth, electrification of transport and industry, data center expansion, and the AI boom-could lead to higher utilization of TransAlta's assets and sustained revenue and EBITDA growth over time.
  
• The global acceleration of decarbonization, increasing ESG capital flows, and policy tailwinds are supporting significant expansion of renewables, reinforcing TransAlta's long-term growth prospects as it transitions further away from coal and invests in wind, solar, and storage, which could bolster margins and earnings stability.
  
• The company's shift toward a higher proportion of contracted revenues-with a near-term goal of more than 70% contracted versus merchant exposure-could reduce earnings volatility and drive more consistent net cash flow, making its financial profile increasingly resilient.
  
• TransAlta has demonstrated access to competitive capital through successful debt offerings and an improving balance sheet, positioning it to execute on growth projects and M&A activities that could drive multi-year compounding in free cash flow and earnings per share.
  
• Strategic investments and partnerships, such as with Nova Clean Energy in the U.S., provide TransAlta with preferential access to high-return late-stage renewable projects, potentially enabling portfolio growth at attractive returns and supporting revenue and net margin expansion in the latter part of the decade.

Valuation

• The assumed bearish price target for TransAlta is CA$13.5, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of TransAlta's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$20.0, and the most bearish reporting a price target of just CA$13.5.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be CA$2.1 billion, earnings will come to CA$59.6 million, and it would be trading on a PE ratio of 82.0x, assuming you use a discount rate of 7.7%.
• Given the current share price of CA$17.1, the bearish analyst price target of CA$13.5 is 26.7% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.