TC Energy, formerly TransCanada Pipelines is a portfolio staple for many Canadians. It is a quasi utility with pipelines and energy production. And the company is and will participate in the green energy transition. The stock price took an additional hit when they announced an asset sale. TC Energy will also split into two – a liquids pipeline company and a natural gas and power asset company. The stock now trades at prices not seen since 2016. What’s up with TC Energy and the pipelines?
Readers will know that I own TC Energy (TRP/TSX) and Enbridge as part of my Canadian Wide Moat Portfolio. The stock prices for the pipelines, telco and banks have certainly taken a hit since the spring of 2022. I have long suggested that you consider the wider moat portfolio that includes the grocers and railways. You’ll find a couple of successful “picks” in that post as well.
In price terms, I am experiencing the negative effects of concentration risk. That said, I am not at all concerned. And perhaps there is value to be found in a few of Canada’s beat up sectors. And there is very good value to be found in the Canadian equity market index funds.
As always, this post in not advice.
A look at TC Energy and the pipelines
In the Globe & Mail John Heinzl offered why selling TC Energy now would be a mistake.
In the name of readability, I have not used quotation marks for the following content from John.
When the extent of Algonquin’s problems became known late in 2022, analysts immediately questioned the sustainability of the dividend. Two months later, Algonquin slashed its payout by 40 per cent.
I’m not hearing the same speculation about TC Energy. Even as it plans to split itself into two companies next year – one holding its liquids pipelines business, the other its natural gas and power assets – the combined dividends from both companies are expected to be the same as before the split.
More dividend growth likely to come
What’s more, the company recently reiterated its forecast that the total dividend will continue to grow by 3 to 5 per cent annually. Is that a slam dunk? No. Dividend increases aren’t official until the board approves them. But unless things deteriorate dramatically, a cut does not appear to be in the cards.
TC Energy has a substantial cash flow buffer protecting its dividend. In 2022, it paid out 49 per cent of its adjusted funds from operations (AFFO) – a measure of the cash-generating ability of the business – as dividends. For 2023 and 2024, the AFFO payout ratio is expected to rise to 53.6 per cent and 55.3 per cent, respectively, according to estimates by Robert Catellier, an analyst with CIBC Capital Markets. That still leaves a significant cushion for the dividend.
The stock’s valuation is attractive
Rising interest rates and ballooning costs for TC Energy’s Coastal GasLink project have been hammering the company’s shares for more than a year. The stock came under renewed pressure in July when the company announced it was selling a 40-per-cent stake in its Columbia Gas and Columbia Gulf transmission assets to a joint-venture partner for $5.2-billion, just six years after acquiring parent Columbia Pipeline Group.
The good news is that the sale will provide cash to reduce TC Energy’s uncomfortably high debt load, giving it more financial flexibility to pursue its $33-billion capital program, which includes investments in its natural gas pipelines, Bruce Power nuclear operations and decarbonization initiatives. The bad news is that the price of the Columbia sale represented a multiple of about 10.5 times earnings before interest, taxes, depreciation and amortization (EBITDA) – lower than the 11 times EBITDA multiple at which analysts had been valuing potential asset sales.
Predictably, the market took the news badly. TC Energy’s announcement a few days later that it plans to spin off its liquids pipelines into a new company only added to investors’ unease. The stock promptly fell to its lowest levels since January, 2016.
But that’s when the bargain hunters stepped in. Prior to this week’s rebound, the shares were trading at about 10.5 times estimated 2024 earnings per share, the lowest price-to-earnings multiple since 2005, RBC Dominion Securities analyst Robert Kwan said in a note to clients.
“We believe the stock setting new P/E valuation lows is unwarranted, and that it is not unreasonable for the stock to recover” to a P/E of about 12.5 times, he said, implying a target price of about $54. The shares closed Friday at $48.19, up $2.94 or 6.5 per cent on the week, with a yield of 7.6 per cent.
The Coastal GasLink nightmare may be nearing an end
When TC Energy announced Coastal GasLink – a 670-kilometre pipeline that will carry natural gas across Northern British Columbia to a liquefaction facility in Kitimat – the cost was initially estimated at $6.2-billion. But owing to a confluence of factors, including the pandemic, soaring labour costs, skilled worker shortages and environmental protests, the price tag had risen to an estimated $14.5-billion as of February.
Given the project’s history of massive cost overruns, investors were relieved when TC Energy said recently that it expects to finish construction of the pipeline – which is more than 90-per-cent complete – by the end of the year and within the revised budget. Some investors (this one included) will probably be sleeping with one eye open for the next few months, but when the Coastal GasLink construction debacle is behind it and the project is generating cash flow – instead of consuming it – more investors may start to warm up to the stock.
“We share investors’ disappointment and regret holding the stock through this turbulent time, but we do not believe it is the right time to sell the shares,” said Cory O’Krainetz, an analyst with Odlum Brown, in a note following TC Energy’s second-quarter results late last month. “TC still owns critical natural gas infrastructure and has numerous opportunities to participate in the global energy transition. The dividend yield is also compelling at close to 8 per cent.”
Stocktrades take on TC Energy
Pipelines have been getting plenty of attention in recent weeks thanks to TC Energy’s decision to spin off its liquids segment. We’ll get to that in a moment, but in general midstream companies haven’t had the greatest year.
Outside of Keyera (KEY) which is sitting on returns of 5.14% YTD, Canada’s largest pipelines are all trailing the S&P Composite Index in a material way. As of writing, every other major midstream company in Canada is sitting on double-digit losses.
This shouldn’t be all that surprising for investors. As high CAPEX companies with large debt loads, as rising rates not only cuts into their profitability, but also makes maintaining current assets and funding growth more expensive. This is why there is a large, industry-wide pullback.
Strong cash flow is key
That is the bad news. The good news is that for the most part, we are not seeing any danger of distribution cuts among the major players. They still generate strong cash flows and while the dividends as a percentage of earnings may look suspect, they are always best compared to cash flows and there are no major red flags.
For those looking to be opportunistic, it may also be an excellent time to accumulate as most are trading at valuations not seen in years and the yields are very attractive.
To close, let’s chat about the most recent news out of TC Energy, which is down by ~21% in 2023. TC Energy announced that it was going to split into two companies via a tax-free spinoff its oil pipelines business. What is left will be as follows:
TC Energy: Natural gas pipelines, storage, and power businesses
Liquids Pipelines Company: Name TBD and will be a liquids pipelines and storage business.
TC Energy will likely provide higher growth and higher valuation, whereas the Liquids Pipeline Company will be lower growth and possibly trade at discounted valuations. They talk a lot about debt reduction, but we’d argue that would have occurred regardless since it is relying on asset sales to reduce leverage.
The company did re-iterate sustainable dividend growth, but once again – this mirrors previous forecasts. Outside of a potential $100M increase in EBITDA by 2026, there lacks any real data of substance to really get us excited about the spinoff.
We could be looking at a situation where these two pieces offset each other leaving current shareholders no better off. All in all, we view the split as a net neutral. They effectively added another level of complexity to the business so they can better focus on the individual businesses. While this ‘strategic focus’ could be beneficial, once again – one could make the argument that a simple internal restructure could have achieved that.
Post-spinoff, we view TC Energy as the more attractive business as it has better growth prospects. It is our assumption that the Liquids Pipeline business will generate more yield but offers little else in terms of attractiveness – at least based on the information at hand.
Motley Fool likes pipelines
Motley Fool thinks that TC Energy, Enbridge and Pembina are screaming buys in 2023.
From that post, you’ll see that MF has Enbridge and Pembina as superior to TC Energy. It’s a nice 3-pack. It might be a nice total return opportunity, generated mostly by dividend reinvestment. But it’s also a nice bond proxy for retirees and near retirees.
Why is Pembina Pipeline stock a screaming buy in August?
Like Enbridge, Pembina Pipeline has better fundamentals than TC Energy. Pembina’s leverage ratio is 3.6 times, and its dividend-payout ratio is 57%. While it doesn’t have +20 years of dividend-growth history like the above two, it is a good dividend payer. Until last year, Pembina paid a monthly dividend but changed the frequency to quarterly in 2023. It has grown its dividend in 10 out of 11 years at a compounded annual growth rate of 5%.
Pembina stock is trading closer to its 52-week low, creating an opportunity to lock in a 6.5% yield.
On Enbridge …
Things are working well for Enbridge, which makes it unlikely for the company to consider a spinoff. It pays out 60-70% of distributable cash flows (DCF) as dividends and keeps the remaining in reserve for future usage. It slowed its dividend growth to 3% after the pandemic to keep the dividend in sync with its policy (it determined 2023 dividends based on the 2022 DCF). As 2022 and 2023 saw strong growth in oil and gas volumes, Enbridge saw higher profits, which it used to fund its gas pipelines, as it looks to tap North America’s liquefied natural gas (LNG) export opportunity.
And here’s an interesting bit on a $2000 investment in the 3 pipes.
That works out to an average yield of 6.7%.
A little leverage for your utilities?
You might even have a look at HUTS Enhanced Utilities ETF from Hamilton that applies 25% leverage on the broader utilities space. In addition to the pipelines, it will include traditional utilities and the modern utilities known as the telcos. I hold a modest position of HUTS in my TFSA.
Here’s building the big dividend retirement portfolio that mentions HUTS.
Also in the Globe & Mail, David Perman suggests that TC Energy has a recovery plan.
The quarterly payout, currently 93 cents per share or $3.72 annually, appears safe, too: The company is distributing less than 54 per cent of its estimated cash flow for 2023, according to Robert Catellier, an analyst at CIBC Capital Markets, giving it some breathing room.
As well, Mr. Catellier expects that TC Energy can raise its dividend by 3 per cent to 5 per cent annually through 2026, propelled by more than $30-billion of growth projects and the company’s own dividend projections.
Experts appear to agree that the dividend is well covered, and we will likely see some modest dividend growth in the near future.
Pipelines, for retirees and accumulators?
The pipelines will certainly look attractive to retirees and near retirees. We might think of utilities as bond proxies. Add in the fact that we can earn up to 5.5% with GICs and things are looking very good for retirees. We can build a very attractive income base.
Readers will know that I also like using defensive sectors for retirement. We can use equities for growth, while also playing defense.
Generous dividends + generous cash yield + defense + portfolio growth = retirement success.
Of course, also add in the financial plan and retirement cash flow plan.
When the opportunity presents itself (funds available in my RRSP account), I will be eager to add to my pipelines. And I will keep both of the TC Energy holdings. I’d be happy to add to the banks and telcos as well.
Thanks for reading. What’s your take on the pipes? We’ll see you in the comment section.
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