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Patrick McKeough is one of Canada’s top safe-money advisors. The Wall Street Journal, Forbes and The Hulbert Financial Digest have all recognized his ability to find stocks with hidden value. He is editor and publisher of The Successful Investor, Stock Pickers Digest, Wall Street Stock Forecaster and Canadian Wealth Advisor; inventor of the Quick Profit/Value System and the ValuVesting System™. A best-selling Canadian author, he wrote Riding the Bull, the book that predicted the 1990s stock-market boom.

Coal restrictions burden these four

August 13, 2010 -  Be the first to comment
Posted by: Pat McKeough Filed in: Commodity Investments
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The federal government plans to phase out coal-fired power plants by around 2025. Under the proposals, utilities would have to close their coal-fired plants when they reach 45 years of age, or when their power-purchase contracts with provincial electricity regulators expire, whichever is later. Coal-plant operators may extend the lives of these plants if they can lower their carbon emissions to the same level as natural-gas-fired plants.

The plan is still in its early stages, and much could change before it comes into effect in 2011. The new rules will hurt some power producers more than others. But these four utilities should be able to pass most of the extra costs on to their customers.

CANADIAN UTILITIES LTD. (Toronto symbols CU (class A non-voting) $47 and CU.X (class B voting) $47; Income Portfolio, Utilities sector; Shares outstanding: 125.8 million; Market cap: $5.9 billion; Price-to-sales ratio: 2.2; Dividend yield: 3.2%; SI Rating: Above Average) distributes electricity and natural gas in Alberta. It also operates 20 power plants: 15 in Canada; three in Australia and two in the U.K. As well, the company sells its engineering services to other firms. ATCO Ltd. (also in this issue) owns 52.2% of Canadian Utilities.

The company operates just two coal-fired plants, both of which are in Alberta. However, Canadian Utilities gets 29% of its electricity from these plants, so it may convert them to burn natural gas. It gets the remaining 71% of its power from its natural gas-fired plants.

Meanwhile, Canadian Utilities earned $76.3 million, or $0.61 a share, in the three months ended June 30, 2010. That’s up 3.8% from $73.5 million, or $0.59 a share, a year earlier. These figures exclude unusual items, mostly gains and losses on hedging contracts that Canadian Utilities uses to lock in natural-gas prices. The company’s power plants paid less for gas in the quarter; that was the main reason for the higher earnings.

Revenue rose 7.6%, to $648.6 million from $602.7 million. Canadian Utilities sold its power for higher rates in Alberta, and opened a new power plant in Australia. That offset lower revenue from its natural-gas storage business.

The company will probably earn $3.27 a share in 2010. The stock trades at 14.4 times that estimate. That’s a reasonable p/e ratio in light of Canadian Utilities’ high-quality regulated operations, which give it steady cash flows.

Canadian Utilities is a buy. The more liquid class “A” non-voting shares are the better choice.

FORTIS INC. $28 (Toronto symbol FTS; Conservative Growth Portfolio, Utilities sector; Shares outstanding: 172.9 million; Market cap: $4.8 billion; Price-to-sales ratio: 1.4; Dividend yield: 4.0%; SI Rating: Above Average) is the main electricity supplier in Newfoundland and Prince Edward Island.

As well, Fortis operates power plants in other parts of Canada, the U.S., Belize and the Cayman Islands. It also operates hotels in Atlantic Canada.

The company has been buying other firms and assets outside of its main market in Atlantic Canada. These purchases have been the reason for much of its growth in the past few years.

In May 2004, Fortis paid $1.5 billion in cash and stock for regulated electrical utilities in Alberta and B.C. In May 2007, it paid $3.7 billion for the regulated gas distribution business of Terasen Inc. (formerly called BC Gas), which has 940,000 customers in British Columbia.

In the three months ended June 30, 2010, Fortis’s earnings rose 3.7%, to $55 million from $53 million a year earlier. Terasen contributed $17 million, or 31% of the total, up 21.4% from $14 million a year earlier. That’s because cooler weather pushed up gas demand during the quarter. The gains from Terasen helped offset flat earnings at Fortis’s electrical utilities in other parts of Canada and the Caribbean.

Earnings per share rose 3.2%, to $0.32 from $0.31, on more shares outstanding. Revenue rose 10.6%, to $836 million from $756 million.

Fortis is spending $5 billion on new projects and upgrades over the next five years, including $1.1 billion this year. Among these projects is a $200-million liquefied natural-gas storage facility on Vancouver Island. That will let Terasen buy gas and store it in the summer, when prices are lower. It can then sell the gas in the winter, when prices rise.

The stock trades at 17.0 times the $1.65 a share that Fortis should earn in 2010.

Fortis is a buy.

TRANSALTA CORP. $21 (Toronto symbol TA; Conservative Growth Portfolio, Utilities sector; Shares outstanding: 220.0 million; Market cap: $4.6 billion; Price-to-sales ratio: 1.6; Dividend yield: 5.5%; SI Rating: Average) operates over 85 power plants in Canada, the U.S. and Australia.

Coal-fired plants account for about 53% of TransAlta’s production. Natural gas supplies 25%, and the remaining 22% comes from hydroelectric and renewable sources.

TransAlta prefers to own unregulated plants. That leaves it more exposed to sometimes volatile electricity prices. However, power demand should keep rising in the next few years as the economy continues to recover.

To cut its reliance on coal-fired plants, TransAlta paid $755 million for Canadian Hydro Developers Inc. in November 2009. Canadian Hydro has 21 power-generating facilities in Alberta, B.C., Ontario and Quebec.

TransAlta’s revenue fell 0.5% in the three months ended June 30, 2010, to $582 million from $585 million a year earlier. Lower electricity prices offset the extra power from Canadian Hydro.

The company earned $51 million, or $0.23 a share. If you exclude a one-time tax gain, TransAlta would have earned $21 million, or $0.10 a share. Still, that’s a big improvement over the $6 million, or $0.03 a share, it lost a year earlier.

TransAlta has had to shut down some of its plants for maintenance. As a whole, they operated at 81.9% of capacity in the latest quarter, down from 82.8% a year earlier. However, the company expects that to rise to 90% by the end of 2010.

TransAlta’s shares trade at 19.1 times its likely 2010 earnings of $1.10 a share. That’s a higher p/e ratio than other power utilities, but it’s still reasonable in light of TransAlta’s improving earnings.

TransAlta is a buy.

EMERA INC. $26 (Toronto symbol EMA; Income Portfolio, Utilities sector; Shares outstanding: 113.7 million; Market cap: $3.0 billion; Price-to-sales ratio: 1.9; Dividend yield: 4.3%; SI Rating: Average) owns Nova Scotia Power Inc., which is Nova Scotia’s main electrical-power supplier. This subsidiary supplies 94% of Emera’s revenue. The remaining 6% comes from investments in power companies in the U.S. and the Caribbean.

The company has undertaken a number of projects that have diversified its operations, including its Brunswick Pipeline, which carries natural gas from Saint John, New Brunswick, to the U.S. border. This line began operating in July 2009.

In the three months ended June 30, 2010, Emera earned $29.6 million, or $0.26 a share. The Brunswick Pipeline contributed $6.8 million, or 23%, of its total earnings. Despite this, the company’s earnings fell 30.2% from its year-earlier earnings of $38.1 million, or $0.33 a share.

That’s because Nova Scotia Power’s earnings fell 34.6%, mainly because of rising operating costs, including pension obligations. As well, the weather was warmer than the year-earlier quarter. That prompted customers to use less electricity to heat their homes. As a result, residential power demand fell 3.2%. Emera’s overall revenue rose 2.3%, to $341.5 million from $333.8 million.

The company uses coal and oil to generate about 80% of its electricity. However, investments in wind farms and tidal-power projects will help it meet Ottawa’s new greenhouse-gas standards. As well, it should be able to comply with a new Nova Scotia law that requires 25% of the province’s power to come from renewable sources by 2015.

Emera should earn $1.57 a share in 2010. The stock trades at 16.6 times this estimate.

Emera is a buy.

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