TransCanada Corp Will Survive Keystone XL

By David Dittman • September 28, 2011 • Canadian Edge Weekly

We’ve written at length in this space about the importance of TransCanada Corp’s (TSX: TRP, NYSE: TRP) Keystone XL project, the USD7 billion pipeline that would nearly double the size and capacity of the Keystone Pipeline system with an expansion to the US Gulf Coast.

Upon XL’s completion the Keystone system will be able to deliver approximately 1.1 million barrels per day (bbl/d) of Canadian crude oil to US refineries. Canada currently exports about 800,000 bbl/d of oil sands output to the US.

Keystone XL is an important initial step in what will be a long process of establishing a North American energy infrastructure network that’s sufficient to support the exploitation of domestic energy reserves. This process is a critical element of shaking the US, in particular, out of its economic malaise. And it’s an important part of securing Canada’s long-term stability and ensuring it’s able to live up to its potential in this rapidly changing global economic order.

But at the end of the day what we do at Canadian Edge is track businesses, looking for high-quality dividend-payers capable of building wealth for investors over time. For TransCanada, it’s becoming pretty clear that all this drama over XL, featuring faded Hollywood stars Darryl Hannah and Margot Kidder, is weighing on its share price. That’s unfortunate, because the company has much more going on than this one project, as important as it is.

TransCanada has executed an aggressive capital spending program outside the Keystone system; over the last 12 months alone the company has brought gas pipelines in Alberta, Mexico and the US West and new power plants in Arizona and Ontario on line. All these projects are now generating cash flow and will boost TransCanada’s earnings, with dividend growth and share price gains to follow. Should TransCanada win approval for XL from the US Dept of State and then successfully fend off the army of interest-group lawyers that’ll inevitably attack growth will accelerate that much more.

TransCanada stock is currently yielding about 4 percent, and it’s selling for less than two times book value, despite posting 30 percent, 27 percent and 18 percent earnings growth the last three quarters. For comparison’s sake, Enbridge Inc (TSX: ENB, NYSE: ENB), along with Kinder Morgan Energy Partners LP (NYSE: KMP) the other major owner and operator of the oil and gas pipeline network that connects Canada to the US, is priced at more than three times book value.

Kinder Morgan trades for 2.9 times book. Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF)–our one of our favorite companies in Canadian Edge, with a total return or more than 400 percent in US dollar terms since original recommendation back in August 2004–is trading for more than four times book value.

Bay Street is generally positive on the stock, with 10 analysts’ recommendations meeting Bloomberg’s standardized definition of “buy” within its ratings system, four “holds” and one “sell.” The average target price among the 11 analysts who’ve provided one–which is a true target, the level to which the analyst forecasts the stock price will rise or fall, rather than a value-based “buy under” level, which is the way we operate in Canadian Edge–is USD45.54. TransCanada closed at USD41.28 on the New York Stock Exchange on Wednesday.

The most compelling aspect of the TransCanada story from an income investor’s perspective is its dividend track record. The board has raised the quarterly payout five times since global markets first suffered the paroxysms that continue to afflict them today; the stock now pays CAD0.42 per share per quarter.

TransCanada’s ability to sustain and grow its dividend does not, in other words, depend on Keystone XL. In fact, TransCanada is poised to grow regardless of how the US political process dispenses with this key infrastructure project because of what could be a substantial effort to build out Canada’s infrastructure.

Keystone XL: The Companies Beyond the Controversy

“In an economic climate where the world debates how much public money to borrow to create stimulus jobs,” said the Honorable Jim Prentice, who is now senior executive vice-president and vice chairman of Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM), in a speech this week to the Atlantic Provinces Economic Council, “Canada stands alone in terms of its potential to chart a different course.”

Mr. Prentice–from January 2006 until November 2010 one of the most senior Ministers in the Canadian Government, serving variously as the Minister of Industry, the Minister of the Environment and the Minister of Indian Affairs and Northern Development–is a compelling advocate on behalf of research compiled by CIBC World Markets economists that suggests investment in energy infrastructure driven by the private sector will help buffer Canada should the global economy result in any further turbulence and also underpin its growth for decades to come.

CIBC has made its conclusions available to the public via downloadable pdf here. The thrust of the report, “Energizing Infrastructure,” is as follow:

In what looks to be an extended period of sluggish global growth, Canada will have to be more self-reliant in creating jobs. But our own consumers and governments are now feeling less eager to continue a debt-financed spending binge. That leaves capital spending as the last frontier where growth opportunities might allow Canada to outperform other major industrialized nations.

Government-funded public works projects played a role in softening the recession, but fiscal restraint is now the watchword. It is therefore imperative to seek out projects where a potential revenue stream could be used to leverage private sector funding or provide an economic return on any capital employed by crown corporations.

Fortunately, there are major energy infrastructure projects on the table that could fit the bill. Under discussion are a string of large-scale hydroelectric power projects from coast to coast. Private sector investment is already driving the expansion of Canada’s oil sands. But pipelines and LNG facilities could also be part of the picture to expand our ability to move oil and gas to more valuable markets. Add it all up, and we have the potential to drive capital spending at a pace not seen in generations.

CIBC’s report is full of data, including staggering figures on Canada’s “infrastructure deficit,” a yawning gap of approximately CAD130 billion, up from CAD60 billion in 2003. This reflects the fact that most of Canada’s civil infrastructure is more than 50 years old and has used up most of its life expectancy. And life expectancy deteriorates rapidly as maintenance is delayed, which is more and more the case across North America.

A lot of government money has been spent already on municipal projects in the aftermath of Canada’s stimulus efforts. What can and should follow, provided government plays its roll properly, is a surge of private investment in energy projects, including Canadian oil sands infrastructure as well as power generation facilities across the country.  

Meanwhile, we discuss TransCanada’s prospects and those of other companies–including oil and gas pipeline operators as well as electric power generators–in the September Canadian Edge feature article Playing Power and Pipes.

Keystone XL: The Companies Building Power and Pipes Down Under

I would point out to Mr. Prentice, although I clearly agree with his view that Canada is extremely well positioned relative to most of the developed world, that it is hardly unique. Australia, as Elliott Gue, Roger Conrad and I discuss in a special InvestingDaily.com presentation, occupies similar rare ground here in the early part of the 21st century.

Like Canada, Australia is benefitting from and will continue to enjoy the long-term effects of heavy investment in an ample store of natural resources. And like Canada, Australia’s is an equity-friendly culture, where stock ownership among the general population is highest in the world and where companies pay world-beating yields.

And like Canada, power and pipes are an integral part of a long-term wealth-building story. Power and pipes, as well as energy infrastructure, are the subject of the In Focus feature in the inaugural issue of Australian Edge, which is available now at www.AussieEdge.com.

The Roundup

It’s hard to imagine a worse follow-up to now-sold former Canadian Edge Portfolio Holding Yellow Media Inc’s (TSX: YLO, OTC: YLWPF) recent interactions with investors, but Marc Tellier provided it Wednesday during a brief “conference” call that featured only a statement by the CEO and no question-and-answer period. In sum, Yellow is taking a CAD2.9 billion impairment charge related to the recent precipitous decline in the market value of business; is paying back CAD500 million of and reducing to CAD250 its revolving credit agreement; and is eliminating its dividend altogether.

The impairment charge to net earnings is a non-cash charge and won’t affect operations, liquidity or cash flow, Mr. Tellier noted. “It also reflects,” according to the CEO, ominously, “the uncertainties if and when new product introduction will compensate for the decline in print trend and revenues and margins from recent business acquisitions.” Second-quarter results demonstrated that management has been unable to make up for the deterioration of its legacy business fast enough.

It seems to be a matter of time for the company, which still bears a substantial debt burden. We’ll follow what happens as it makes its CAD25 million payments leading up to a February 2013 refinancing. But it can’t bode well for third-quarter results that Yellow is out in front of investors and won’t take any questions. Mr. Tellier promised to provide a more detailed along with third-quarter results, which will be revealed on or around Nov. 3. Sell Yellow Media if you haven’t yet.

Here are links to analyses of second-quarter earnings for all Portfolio Holdings, followed by reporting dates for the third quarter.

Conservative Holdings

Aggressive Holdings

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