Stock Analysis: TransCanada Corporation

One of the four stocks on my September watch list is TransCanada Corporation. Although well known to Canadian dividend growth investors, despite also being traded on the New York Stock Exchange (NYSE: TRP) and its proposed Keystone pipeline being vetoed by President Obama in February 2015, the company isn't a familiar name for most US dividend growth investors. The analysis below is meant to demonstrate why I think TransCanada is worthy for consideration to include in a dividend growth portfolio.

Business Overview: 

The company company has operated for over 60 years and reports on three segments: natural gas pipelines (56% of H115 revenues), liquid pipelines (25% of H115 revenues), and power generation (24% of H115 revenues). TranCanada has over 68,000 kilometers of natural gas pipelines, The company is also one of North America's largest providers of gas storage with over 368 billion cubic feet of storage. Lastly, the company is a growing power producer with interests in over 10,900 megawatts of power generation.

Since 2000, the company has grown its asset base from CAD $26 billion to $63 billion of quality, long-life pipeline and power generation assets. TransCanada reports that they have $46 billion of new growth projects under long-term contracts or regulated business model.

Financial Results & Credit Ratings:



Over the past 4.5 years, TransCanada has managed to grow their revenue at a compound annual growth rate of 9%, while growing their net income at 7%, and EBITDA at 10.2%. The company's EPS CAGR over the same period was 6.5%, while their dividends grew at 4.6%.

The company has issuer ratings of A-/Stable from S&P and Baa1/Stable from Moody's.

Dividend Growth, Yield and Safety:


Since 2000, TransCanada has grown its dividend from $0.80 per share to $2.08 per share, for a CAGR of 6.6%. During Q2 2015, the company indicated that they remain committed to 8-10% dividend growth through 2017. This commitment was first made in the winter of 2015, when the company stated their intentions to grow their dividend by at least 8% through 2017 based on its strong asset base, and predictable earnings and cash flow generation from its sizeable portfolio of small to medium-sized, near-term growth projects.

On September 17th, TransCanada's dividend yield was approximately 4.7%.

Although the company's payout ratio of 81.2% might seem high when calculated using EPS (see the table in the Financial Results section), it is only 43.8% using EBITDA which gives a better indicator of distributable cash for pipelines.

Analysts Recommendations & Valuations:

Of the 14 analysts who cover the company, 6 rate its stock a Buy, 7 rate it a Hold, and 1 rates it a Sell. The consensus analyst price target is CAD 59.19.

On September 17th, TransCanada trades at a Price / LTM EPS multiple of 18.2X. This multiple compares to an average Price / LTM EPS multiple of 21.6X YTD 2015, and an average Price / LTM EPS multiple of 19.7X over the past 5 years.

Using a very simplified dividend discount model, assuming a 5% growth rate, and an 8% required return, the fair value of the company's shares would be $72.80.

Key Risks:

Key risks relating to TransCanada include:
- Heightened regulatory and permitting risk to pipeline approvals due to political and environmental concerns.
-  High capital expenditures associated with their large scale projects that will require significant external funding.
- Uncertainty related to both the likelihood and timing of large scale projects that will also expose the company to execution risk. 
- Safety risk: Leaks, ruptures, and other safety concerns can cause delays in approval and reputation damage to pipeline operators.
- Sensitivity to commodity prices: If the price of oil or natural gas was to stay at a depressed state for a long period of time, the rates pipeline operators could charge when contracts are renewed would decrease. 

Final Thoughts:

Given the current valuation of TransCanada compared to past P/E multiples, the company's impressive history of revenue and dividend growth, and their strong balance sheet as evidenced by their investment grade credit ratings, I'm looking to add to my position. I'm aware of the key risks of investing in pipelines, but think their competitive advantage of being difficult to duplicate without intense capital investment, and the fact that they majority of the revenues they collect are predictable and subject to long-term contracts, help compensate me for assuming the risks involved.

Do you hold shares in any pipelines and are there others you would consider as future investments?