TransAlta Corporation (NYSE:TAC) Q2 2023 Earnings Call Transcript

TransAlta Corporation (NYSE:TAC) Q2 2023 Earnings Call Transcript August 5, 2023

Operator: Good morning. My name is Joelle, and I will be your conference operator today. At this time, I would like to welcome everyone to TransAlta Corporation’s Second Quarter 2023 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Ms. Valentini, you may begin your conference.

Chiara Valentini: Great. Thank you, Michelle. Good morning, everyone, and welcome to TransAlta’s second quarter 2023 conference call. With me today are John Kousinioris, President and Chief Executive Officer; and Todd Stack, EVP, Finance and Chief Financial Officer. Today’s call is being webcast, and I invite those listening on the phone lines to view the supporting slides that are posted on our website. A replay of the call will be available later today, and the transcript will be posted to our website shortly thereafter. All the information provided during this conference call is subject to the forward-looking statement qualification set out here on Slide 2. It’s detailed further in our MD&A and incorporated in full for the purposes of today’s call.

All amounts referenced during the call are in Canadian currency, unless otherwise noted. The non-IFRS terminology used, including adjusted EBITDA, funds from operations, and free cash flow are also reconciled in the MD&A for your reference. On today’s call, John and Todd will provide an overview of the quarter’s results. After these remarks, we will open the call for questions. And with that, let me turn the call over to John.

John Kousinioris: Thank you, Chiara. Good morning, everyone, and thank you for joining our second quarter results call for 2023. As part of our commitment towards reconciliation, I want to begin by acknowledging that TransAlta’s head office, where we are today, is located in the traditional territories of the Niitsitapi, the people of the Treaty 7 Region in Southern Alberta, which includes the Siksika, the Piikani, the Kainai, the Tsuut’ina, and the Stoney-Nakoda First Nations, as well as the home of Metis Nation Region 3. TransAlta had another exceptional quarter. We’re proud of the overall performance of our company and our employees. We delivered $387 million of adjusted EBITDA, 39% increase over our Q2 2022 results, and free cash flow of $278 million or $1.05 per share, a 94% increase over Q2 2022 results on a per share basis.

Both metrics beat our expectations for the quarter. Our results benefited from continuing strong power prices in Alberta and Mid-C, lower natural gas commodity prices, and the success of our asset optimization and hedging strategies. Overall, the Alberta market was impacted by tighter supply conditions resulting from transmission constraints, which limited imports from adjacent markets, supportive power prices in adjacent markets, which also lowered net imports into Alberta and encouraged exports of power from Alberta to the Pacific Northwest, periods of overlapping outages, and lower-than-normal wind resources which impacted renewable generation. We also saw significantly lower fuel costs compared to last year given lower overall commodity prices and the impact of our hedging program.

The higher realized prices, coupled with lower realized gas prices, delivered higher gross margins for our portfolio compared to Q2 2022. Our overall availability was 85%. Apart from our ongoing outage at Kent Hills, our performance had weaker availability due to higher planned outages in the hydro and gas segments, which was partially offset by better performance at Centralia compared to last year. During the quarter, we delivered on a number of key priorities. Beginning with the proposed acquisition of TransAlta Renewables by TransAlta Corporation. This transaction will not only simplify our corporate structure, it will enhance our strategic position and provide alignment within our Clean Electricity Growth Plan in a manner that we believe will create value for all our shareholders.

The combination will also deliver capital efficiencies and enhance cash flow predictability and diversification for both sets of shareholders while preserving the combined company’s ability to realize future growth. On the growth side, our development team continues to expand our pipeline, adding another 344 megawatts of growth projects, 300 megawatts of which are renewables projects based in the U.S. and Australia, and 44 megawatts relate to a new peaker initiative that we have here in Alberta and that I’ll be speaking about shortly. The rehabilitation of Kent Hills is progressing well with 27 of 50 turbines fully reassembled. Turbines are being returned to service, commissioning activities are completed, and to date, 10 turbines have been fully placed back into operation and are earning revenues from New Brunswick Power.

We are now anticipating that the repair costs will increase to about $140 million as we have opportunistically expanded the scope of work to include certain blade repairs which will permit us to defer or avoid future maintenance at the site. We completed $35 million in share buybacks during the second quarter, bringing our total capital return to shareholders during the first half of the year to $71 million through the repurchase of 6.1 million common shares at an average purchase price of $11.62. Our current NCIB program was renewed in May, and we see it as a capital allocation alternative that will help us continue to enhance long-term shareholder value. And finally, with another quarter of strong cash flow, our balance sheet position is strong with excellent liquidity and cash on hand to fund our recently announced transaction with TransAlta Renewables as well as our growth projects.

As you all know, a key priority for the company for 2023 is completing the construction of our contracted renewables projects. We currently have 678 megawatts of projects in the construction phase, representing an investment of $1.4 billion with approximately $1.1 billion spent to date and $300 million left to go. Our 130 megawatt Garden Plain wind farm here in Alberta is nearing completion. All 26 turbines have been assembled and we’re pleased to announce that 23 units are in operation today and available to generate electricity to the grid. We expect to finalize commissioning and declare commercial operations in a week or so following resolution of an outstanding issue with the three remaining turbines. We expect the wind farm to contribute $15 million of contracted EBITDA annually, and so far, we’re pleased with the performance of the turbines at the site.

Our Northern Goldfields solar project in Australia is also reaching its final stages of completion. All major equipment has been installed and construction work is largely complete. Energization and testing processes have commenced. The solar facility is beginning to generate electricity and is expected to achieve full commercial operations in the second half of 2023. This project will deliver approximately $9 million of adjusted EBITDA annually. Construction at the Horizon Hill wind project in Oklahoma is also advancing well, and all major equipment has now been delivered to site. Turbine erection activities are underway, and we’re pleased to report the 27 of the 34 wind turbines are fully assembled. Construction of the transmission interconnection is also underway.

Although our turbine erection activities are progressing, the critical path to our schedule is the completion of the transmission line, which unfortunately is seeing some delay. As a result, we’re now expecting to reach commercial operations during the first half of 2024. At our White Rock East and West projects, equipment deliveries are well advanced and the final blade sets are due to arrive in August. In the meantime, tower assembly has commenced along with the construction of the transmission interconnection. Horizon Hill and White Rock will contribute adjusted EBITDA of over $100 million annually to our company. Finally, our Mount Keith 132kV expansion project is also making progress, with the gas insulated switchgear being installed in August.

The project will achieve commercial operations in the second half of 2023 and contribute approximately $7 million of adjusted EBITDA annually. These projects, along with the Kent Hills’ rehabilitation, constitute the largest construction program that TransAlta has taken on in recent memory. Given the economic and construction environment we’re facing, we’re overall pleased with how our projects are tracking. We’re only slightly above budget on our two U.S. projects and we’re broadly on track with our timing for all other projects. Within our development pipeline, we currently have 418 megawatts of advanced stage generation and transmission projects that we’re advancing towards final investment decisions. They represent additional growth capital of approximately $730 million.

They range from wind generation at Tempest to battery storage at WaterCharger. I’m pleased to share that we’ve added our Pinnacle 1 and 2 projects to our advanced stage development pipeline. Pinnacle 1 and 2 will be a highly flexible and quick ramping peaking facility in Alberta, designed to respond to volatile price environments. As renewables’ penetration advances over time in the province, our expectation is that demand for fast ramping, highly responsive, flexible supply will be needed as a compliment. Our Pinnacle 1 and 2 projects will leverage our existing infrastructure and interconnection at Keephills to deliver exactly this type of capacity. The project comprises four 11 megawatt [indiscernible] generating units. The engines will be connected in pairs with each pair linked to the grid independently.

We expect approvals and permits to be issued in Q4 with a potential in-service date in the second half of 2025. We also continue to advance our growth pipeline. As you recall, in 2022, we added almost 2 gigawatts to our renewable development pipeline across all our regions, providing significant progress towards our longer-term goal of having 5 gigawatts of projects in the pipeline. For 2023, we have an in-year stated goal of adding another 1,500 megawatts of new sites to our pipeline to replenish our growth in the longer term. In the quarter, we added an additional 344 megawatts of future development opportunities, and so far this year, we’ve added 630 megawatts or about 42% of our goal. Notably, in the second quarter, we acquired a 50% interest in the 320 megawatt Tent Mountain pumped hydro energy storage project here in Alberta and a combined 300 megawatts of wind prospects in the U.S. and Australia.

We see continuing strength in power prices in Alberta and Pacific Northwest. In Alberta, forward power prices for the balance of the year are trading higher as a result of continuing conditions of tighter supply, resulting from generation outages, delays in new asset entry and persisting transmission constraints that are limiting imports. We also continue to see supportive prices in adjacent markets, which are experiencing lower-than-normal hydrology. With our strong results this quarter and improved market expectations for the rest of the year, we are once again pleased to increase our financial guidance for 2023. We’re now expecting Alberta prices — power prices to settle the year between $150 to $170 per megawatt hour, about $25 per megawatt hour higher than our guidance in Q1.

We’re raising our expectations for adjusted EBITDA to a range of $1.7 billion to $1.8 billion, representing an increase of 17% over the midpoint of our prior guidance, and free cash flow is now expected to be in the range of $850 million to $950 million, an increase of 29% at the midpoint compared to our guidance at Q1. I’ll now turn it over to Todd for further discussion on the quarter’s financial results.

Todd Stack: Thank you, John, and good morning, everyone. I’ll kick off my comments with a more detailed note — overview of our Alberta portfolio performance. When we announced our guidance in December, our outlook was based on Alberta power prices ranging between $105 to $135 per megawatt hour. Spot prices in the second quarter of 2023 continued to exceed our expectations, settling at $160 per megawatt hour versus $122 in 2022. Year-to-date, pricing through the first half of the year has been stronger than expected at $151 per megawatt hour, and we expect this strength to continue through the end of the year. As John noted, we now expect spot prices to average between $150 to $170 for the full year. Overall, we continue to realize higher merchant power pricing for energy and ancillary services across the merchant fleet in the first six months of the year and were able to optimize our available capacity across all fuel types.

The ability of our hydro fleet to capture peak pricing was demonstrated throughout the second quarter with a realized energy price of $199 per megawatt hour, which represented a 25% premium over the average spot price and delivered a 53% stronger realized price versus 2022. Similarly, our gas fleet exceeded our expectations, capturing peak pricing throughout the quarter, with a realized merchant price of $202 per megawatt hour, which represented a 27% premium to the average spot price. Our merchant wind fleet realized an average price of $75 per megawatt hour, which is below the average price of $96 we saw last year. But on a year-to-date basis, the merchant wind fleet has realized an average price of $83 per megawatt hour, which is tracking 11% higher than what the wind fleet realized in the first half of 2022.

Looking at the balance of the year for 2023, we have approximately 3,600 gigawatt hours of Alberta gas generation hedged at an average price of $102 per megawatt hour, and roughly 88% of our required natural gas volumes are hedged at an attractive price of $2.27 per gigajoule. Our hedging activities aim to mitigate the impact of unfavorable market pricing on the Alberta gas fleet and we continue to retain a significant open position in order to realize higher pricing during times of peak market demand, which was demonstrated in our strong Q2 and year-to-date results. Our financial results for the second quarter were strong. As John noted, we generated $387 million of adjusted EBITDA and an exceptional $278 million of free cash flow. Our performance in the second quarter was led by the gas fleet with adjusted EBITDA of $166 million, a 155% improvement over last year.

The gas segment benefited from expanding gross margins in the Alberta fleet through higher realized prices and lower input costs as hedged and market prices for natural gas declined significantly from last year. The hydro segment also outperformed with an adjusted EBITDA of $147 million, a 67% increase to the same quarter in 2022. Hydro benefited from strong realized pricing as well as from a 20% increase in production over 2022 levels due to higher water resources in the quarter. Higher water resources were driven by timing of the seasonal runoff and higher precipitation. The wind and solar segment underperformed quarter-over-quarter. Although we brought on new production from the Garden Plain facility, we experienced lower overall production due to pervasive, weaker wind and solar resources in all regions compared to the same quarter last year.

We also experienced lower realized merchant pricing in Alberta and lower environmental attribute revenue. Quarterly variability in wind resources expected, and we remain confident in our fleet’s ability to realize its long-term average production levels. Energy marketing had similar performance to last year, and in the quarter, delivered $49 million of gross margin and $43 million of adjusted EBITDA, which is another great result for the segment. Corporate costs increased by $9 million, primarily due to higher incentive accruals, reflecting our strong performance and were also impacted by higher spending on strategic and growth initiatives and from the impact of inflationary pressures. Overall, TransAlta’s results again exceeded our expectations and delivered a great first half of 2023.

The strong performance of our hydro fleet continues to benefit our shareholders. In the second quarter, the hydro assets generated $147 million of EBITDA and are well on track to deliver over $500 million this year. This compares to over $500 million of EBITDA in 2022 and over $300 million in 2021. Although energy production and ancillary service volumes vary quarterly, they remain largely consistent on an annual basis. This provides long-term predictability and [a floor] (ph) to cash flows that is unique to this asset class. In Q2, while the strong water flows increased our energy sales, it did at times limit our ability to provide ancillary services into the market from these units. This resulted in lower ancillary sales from the hydro segment year-over-year.

When this occurs, we are able to backstop the ancillary service sales with our gas fleet, which we did in Q2. During the quarter, we sold approximately 200 gigawatt hours of ancillary services from the gas fleet. Realized pricing continues to be strong with a premium on spot electricity prices of roughly 25% and with ancillary services earning approximately 50% of spot prices. Together, the higher realized prices on both energy and ancillary services and higher energy flows more than offset the impact of lower ancillary service volume in the hydro segment. Before I turn things back to John, I’ll turn to TransAlta Renewables to highlight key details of our acquisition announcement. As John mentioned, we are pleased to announce a path forward on our simplification efforts.

We’ve entered into a definitive agreement where TransAlta will acquire all the issued and outstanding publicly held common shares of TransAlta Renewables. The $13 offer from TransAlta represents an 18.3% premium to TransAlta Renewables’ closing share price at July 10, 2023, and a 13.6% premium based on the prior 20 day volume weighted average price of the TransAlta Renewables common shares. Each TransAlta Renewables shareholder will have the ability to elect to receive $13 in cash for TransAlta Renewables share or 1.0337 TransAlta shares per TransAlta Renewables share or a combination of cash and shares. In each case, consideration is subject to proration, with the maximum cash consideration being fixed at $800 million and the maximum share consideration being equal to 46.4 million TransAlta shares.

Upon closing of the transaction, the pro forma ownership of the combined company will be approximately 85% held by current TransAlta shareholders and 15% held by current TransAlta Renewables shareholders. The Board of Directors of each company has independently determined that the transaction is in the best interest of their company and fair to their shareholders. The transaction was also unanimously approved by the independent members of the TransAlta Renewables Board, and they have unanimously recommended that RNW shareholders vote in favor of the transaction. In terms of next steps, we expect to obtain an interim order from the Alberta Court of King’s Bench, establishing the process for TransAlta Renewables shareholder approval and will mail out the Management Information Circular to TransAlta Renewables shareholders on or about August 25.

The special meeting of TransAlta Renewables shareholders to consider the arrangement is expected to take place on or about September 26. The arrangement must be approved by at least two-thirds of the votes cast by TransAlta Renewables shareholders represented at the meeting and by a simple majority of the minority of public shareholders of TransAlta Renewables represented at the meeting. The transaction is subject to regulatory approvals and other customary closing conditions and is expected to close in early October. And with that, I’ll turn the call back over to John.

John Kousinioris: Thanks, Todd. As I look at our strategic priorities for 2023, our primary goal is to continue delivering clean power solutions to and be the supplier of choice for customers that are focused on sustainable growth and decarbonization. In 2023, we’re focused on progressing the following key goals: reaching final investment decisions on the equivalent of 500 megawatts of additional clean energy projects across Canada, the United States and Australia, and delivering $75 million to $100 million in incremental EBITDA; achieving COD on the Garden Plain wind, Northern Goldfield solar and Mount Keith transmission projects while progressing the White Rock wind and Horizon Hill wind projects to completion early in 2024; expanding our development pipeline by 1,500 megawatts with a focus on renewables and storage; completing the rehabilitation of Kent Hills wind; advancing the long-term contractiveness of our Alberta electricity portfolio; delivering permanent financing for our Oklahoma growth projects; and achieving EBITDA and free cash flow within our increased guidance ranges.

I’d like to close by highlighting what I think makes TransAlta a highly attractive investment and a great value opportunity. First, our cash flows are robust and underpinned by a high quality and highly diversified portfolio. Our business is driven by our contracted wind and solar portfolio, our unique, reliable and perpetual hydro portfolio, and our efficient gas portfolio, all of which are complemented by our world-class asset optimization and energy marketing capabilities. The acquisition of TransAlta Renewables will further diversify and increase the contractedness of our cash flows. Second, we’re a clean electricity leader with a focus on tangible greenhouse gas emissions reductions. This year, we adopted a more ambitious CO2 emissions reductions target of 75% by 2026 from 2015 levels and our Board has recently approved our commitment to net zero by 2045.

Third, as noted earlier, we have a diversified and growing development pipeline and a talented development team focused on realizing its value. And fourth, our company has a sound financial foundation. Our balance sheet is strong and we have ample liquidity to pursue and deliver growth. Finally, our people: our people are our greatest asset, and I want to thank all our employees and contractors for the excellent work they have done to deliver our exceptional quarter. Thank you. I’ll turn the call back over to Chiara.

Chiara Valentini: Thank you, John. Michelle, would you please open the call for questions from the analysts and media?

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from Dariusz Lozny with Bank of America. Please go ahead.

Dariusz Lozny: Hey, guys. Good morning. Thank you for taking my question. Maybe just at the outset, I was wondering if I could get your thoughts on the announcement yesterday from the Alberta Commission that put a pause on new applications for wind and solar. I don’t believe there should be much of a material impact to your pending projects in the pipeline, but maybe if you can comment on that? And maybe more broadly, how do you see this sort of impacting your longer-term plans as far as where to concentrate your development pipeline? Thank you.

John Kousinioris: Good morning, Darius, and thanks for that question. I mean, look, the impact of the announcement yesterday will be limiting, at least for a period of time, the advancement of renewable project in the province for that six-month period while there’s consideration being given to the pathways going forward. I have to say that from our own perspective, we have raised in the past the importance of making sure that we have a balanced approach to the growth that we’re seeing in renewables in the province. I think if people have heard me say this before, it’s like a three-legged stool, and it’s critical that the grid is clean, but also reliable and affordable. And I think spending a bit of time to review, how the system maintains affordability and reliability as we begin to transition towards the lower emitting grid is critical.

So, we’re looking forward to that consultation process that we’ll be having that will involve the Alberta Utilities Commission. We take a long-term view on our development pipeline in Alberta, and I can tell you, it’s business as usual for us in terms of trying to advance our projects here. In specific response to a couple of your questions, we don’t really see it having a significant impact on our advanced stage projects. WaterCharger and Tempest have Alberta Utilities Commission approval and we continue to advance those forward and are working hard to get them completed and announced this year. Pinnacle 1 and 2, which we’ve just announced, would be gas investments in the province. So again, they wouldn’t be impacted by the halt. As we understand it, that is being put in place as a result of the Alberta Utilities Commission decision.

In terms of where we’re thinking overall in Alberta, I would say that we continue to be committed to all of our decarbonization and net zero targets. We continue to see demand for renewables in the province. We expect kind of renewables growth to continue once this review is completed in the province. We are, though, for sure, I would say, turning our minds to what other attributes the system will require in Alberta as it evolves in the coming decade and having fast response battery and some peaking capacity that can create that reliability and stability that the market will need periodically is also something we’re looking at. And that’s really what Pinnacle 1 and 2 are all about, along with WaterCharger.

Dariusz Lozny: If I could ask one more on the updated guidance for the full year. Obviously, very robust results, $200 million more on free cash flow. To the extent that the balance of the year continues to come in above expectations, is there any possibility of perhaps raising the cash contribution in the RNW buy-in? Or is it more or less set as you guys announced earlier in July, and that’s how you plan on proceeding?

John Kousinioris: Yes. No. So the transaction with TransAlta Renewables is fixed. There is, from our perspective, no prospect of any change in the composition of the consideration to that transaction.

Todd Stack: I’d just say that we are conscious that when the transaction closes, there might be some movement in shareholder interests from TransAlta Renewables side. And so you’ll notice that we did reinstate our NCIB program back in May, and so we’re very much able to go out and support the stock if there is some churn.

Operator: Your next question comes from Mark Jarvi with CIBC. Please go ahead.

Mark Jarvi: So just coming back to more to a couple of other questions. One, do you think this will have any impact on, I guess, the outlook for pricing or ancillary services here, if there is a little bit of a slowdown in the — I guess, the penetration ramp up in renewables? And then just maybe clarify, you said nothing, no impact on Tempest, WaterCharger. What about some of the, I guess, the next stage of projects like Riplinger, SunHills? And I guess the last little question would be, if they do constraint where you can cite new projects, can you talk a little bit about the ability to build on existing sites, whether it’s your thermal sites or legacy wind sites?