Dividend income investing helps make passive income, but the strategy can also be fraught with unforeseen risks, as demonstrated in 2022 when highly indebted assets with stable cash flows suffered huge value losses due to record interest rate increases. This challenge was particularly severe for leveraged utilities and real estate portfolios, which couldn’t raise rates quickly enough to keep up with soaring financing costs.
TransAlta Renewables (RNW) stock was no exception in 2023. Despite its monthly dividends offering an 8.5% yield, its shares became undervalued, attracting institutional investors and culminating in its acquisition by TransAlta Corporation (TSX:TA) in October 2023. However, investors could still expect some dividends in 2024.
The renewable energy producer faced significant contract expirations at a time when renewal rates were unsatisfactory, leading to increased uncertainty, unsustainable dividends, and a plunge in share value.
TransAlta Corporation, an independent energy producer with assets in the United States, Canada, and Australia, seized the opportunity to acquire long-term strategic assets at discounted prices. The corporation already owned 60% of TransAlta Renewables, and offered $13 per share (an 18.3% premium) to buy the remaining equity from minority shareholders, valuing the acquisition at $1.4 billion. The compensation included an $800 million cash component, and a maximum of 46,441,764 TA shares at a conversion rate of 1.0337 TA shares for each RNW share held.
So, how much will a TransAlta Renewables investment pay in dividends in 2024?
None. TransAlta Renewables stock no longer exists. However, investors who chose to receive TA stock during the 2023 acquisition deal will instead receive dividends from TransAlta Corporation stock, another utility stock, this year.
RNW stock investors oversubscribed to the TA stock offer, opting for 72,056,140 shares, valuing the dividend-paying shares at more than the cash offer. However, they could only receive the maximum limit of 46,441,764 shares. These newly issued shares will receive $0.24 each in total dividends, amounting to $11.1 million in total payouts for 2024. Given a fair value of $13 per share and the conversion rates applied, the current dividend payout could yield 1.9% to former RNW investors.
Should you buy TransAlta Corporation stock for the dividend?
TransAlta Corporation stock will pay a $0.06 per share quarterly dividend in 2024. The payout currently yields 2.4% annually. The utility stock has paid increasing dividends since 2020, but the current quarterly payout remains far below a pre-dividend-cut level of $0.18 per share in 2015. The company is rebuilding a reputation as a dividend growth stock, even though the business faces significant market headwinds.
TA Dividend data by YCharts
Despite a weaker energy market in Alberta and lower natural gas prices, TransAlta may pay out less than 16.3% of its free cash flow in dividends this year. Free cash flow represents the cash generated from normal business operations, less capital expenditures during the year. The payout is well covered by recurring cash flow and appears sustainable.
Additionally, the company may spend up to $150 million on an enhanced common share repurchase program for 2024. Management aims to distribute up to 42% of the company’s free cash flow through dividends and stock repurchases.
Management is keen to make a TA stock investment pay off positively for loyal investors, despite a tough operating environment.
Consider waiting for clearer skies
TA stock has lost about 25% of its value over the past 12 months due to significant drops in natural gas prices and warmer weather conditions, weakening its revenue base and potentially resulting in lower cash flow yields this year. Market forecasts predict a sustained dip in average electricity prices through 2025.
While aggressive share repurchases and growing dividends could help support the utility stock, the company is burdened with $3.8 billion in net debt, exceeding its $3 billion market value. Leverage remains a significant problem if interest rates stay elevated for an extended period.
Even if TA stock can increase dividends, its current 2.4% dividend yield may not be enticing enough to justify buying TransAlta Corporation stock today given the associated capital risks. Total returns do matter over the long term, and with new capital to deploy more attractive opportunities might be found elsewhere.
