As recession fears continue to grip the market, worried investors should look to defensive stocks such as TransAlta Renewables (TSE: RNW). RNW stock provides a steady dividend even during difficult times. In addition, the company appears to be undervalued, even though analysts have a neutral view of it.
It is defensive because TransAlta Renewables is an electric utility company that owns and operates energy generation and transmission facilities. The operating business segments are Canadian Wind, Canadian Hydroelectric, and Canadian Gas.
How Undervalued is TransAlta Renewables?
I estimate that the fair value of TransAlta Renewables is approximately C$24.36 under current market conditions. With its share price near C$16.70, the stock appears undervalued.
To value the company, I used a single-stage DCF model because its free cash flows don’t grow smoothly and are difficult to predict. For the terminal growth rate, I used the 30-year Government of Canada Bond yield as a proxy for expected long-term GDP growth
Here is my calculation:
Fair Value = Five-Year Average FCF Per Share / (Discount Rate – Terminal Growth)
C$24.36 = C$1.04 / (0.073 – 0.0303)
Dividend Yield is High but Has Been Trending Lower
For income-oriented investors, TransAlta Renewables pays a 5.7% dividend yield on an annualized basis. When taking a look at RNW’s historical dividend yield, you can see that it has trended downwards:
At 5.7%, the current yield is on the low end of the range, indicating that income-oriented investors are paying a premium relative to yields they have been able to receive in the past.
Analysts’ Recommendations on Transalta Renewables
TransAlta Renewables has a Hold consensus rating based on four Holds assigned in the past three months. The average RNW price forecast of $19 implies 13.7% upside potential.
Should Investors Consider Including Transalta Renewables in Their Portfolios?
For investors who want to receive income while also positioning their portfolios more defensively, TransAlta Renewables is a good company to consider.
It pays a juicy dividend, and it is also undervalued according to my valuation. In addition, even though analysts have a Hold rating on the stock, the lowest price target is still higher than the current price.
