Michael O'Brien, vice-president and director at TD Asset Management Inc., says that Canadian pipeline stocks offer good, solid earnings growth, minimal volatility and healthy dividend increases in an environment of historically low interest rates and sluggish economic growth.
"These stocks are not economically sensitive, as most of their returns are either regulated or the subject of long-term contracts," says O'Brien, who manages a Canadian large-cap portfolio at TDAM using a GARP style, or growth at a reasonable price.
He says some analysts consider pipeline stocks to be expensive. "But the earnings visibility of the companies is exceptional in this climate of uncertainty." As an equity investment, "they offer long-term steady capital appreciation, which is the objective of TD's Canadian blue-chip portfolio."
O'Brien notes that an important long-term investment theme that has been driving the Canadian equity market for some time "is the developing economies' demand for our resources -- energy and materials."
Canadian oil and gas has to move from its source to these emerging markets, and pipelines are the conduits, he says. "Therefore, Canadian pipeline companies represent a low-risk, secular play on emerging-markets growth." While the stocks of energy and base-metal producers tend to be more volatile and cyclical, "the long-term case for select high-quality companies in these industries remains intact."
As this year unfolded and the challenges to global economic growth mounted, O'Brien reduced his exposure to resources and other cyclical sectors in favour of more defensive names. One bright spot in the resource space, he notes, has been the performance of gold stocks, "where I have a good absolute exposure." Gold stocks are "a form of portfolio insurance," he adds.
O'Brien has an academic background in political science. He started off in politics on Parliament Hill, where he served as executive assistant to a prominent western MP for three years. "During this time I became interested in finance." He left Ottawa for Bay Street and TDAM in August of 1997.
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He now has responsibility for a number of institutional and high-net-worth mandates at the firm focusing on the Canadian equity market. These include TD Canadian Blue Chip Equity 
, which has assets of roughly $900 million.
TD Canadian Blue Chip Equity, which has 45 names and some modest foreign content, is benchmarked against the S&P/TSX 60 Index. The top 10 names account for 54% of the portfolio.
Relative to this index, the fund has a modest overweight in the energy sector (which includes pipelines) and is "materially underweight the materials sector, which is the most volatile sector in this big-cap index."
O'Brien sees Enbridge Inc. ENB as the "poster child" for the pipeline industry in Canada. Enbridge, which is engaged in energy transportation and distribution, "has completed an expansion phase and its capital expenditure-requirements are more modest."
The company, he says, is expected to produce strong earnings growth and dividend growth over the next few years. "Over the past five years, Enbridge has grown its dividend at a double-digit percentage pace." The stock trades at around 20 times forward earnings and has a dividend yield of more than 3%, "which is around what 30-year Government of Canada bonds are paying, without Enbridge's prospect of dividend growth."
TransCanada Corp. TRP is also in the portfolio. The company is focused on natural-gas pipelines, oil pipelines and electrical power generation. TransCanada has faced political challenges in the United States and environmental challenges over the proposed extension to its Keystone pipeline system south of the border. "What is not recognized is that a large section of this pipeline is already in service in Canada and is producing revenue," says O'Brien.
The extension, Keystone XL, proposed in 2008, would link Canada's oil sands to U.S. refineries. "It will be the cherry on the cake for TransCanada," says O'Brien. The stock trades at 17 times forward earnings estimates and has a dividend yield of 4%.
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| Sept 27 close | $32.52 | $42.23 | |
| 52-week high/low | $33.22-$25.95 | $43.72-$35.49 | |
| Market cap | $25.3 billion | $29.7 billion | |
| Total % return 1Y* | 29.1% | 14.0% | |
| Total % return 3Y* | 20.3% | 7.2% | |
| Total % return 5Y* | 15.1% | 7.0% | |
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| *As of Sept.27, 2011 Source: Morningstar |
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Two major Canadian energy producers in the top five holdings in TD Canadian Blue Chip Equity are Suncor Energy Inc. SU and Canadian Natural Resources Ltd. CNQ.
"Suncor has large, long-life oil-sands assets in Canada, a politically stable area," O'Brien says. The stock has come under selling pressure, with the general retreat among energy producers, "but it should be one of the secular winners." Suncor shares trade at a price-to-cash-flow estimate for 2012 of 4.5 times.
Canadian Natural Resources "stands out in the sector as an exceptionally well managed company, which is particularly shareholder friendly." O'Brien notes that CNQ has a "diverse asset base," which includes the Horizon Oil Sands Project. It also has heavy-oil assets, which have low drilling costs.
In contrast to some of its peers, he says, CNQ stopped drilling for natural gas, given the depressed commodity price. Instead, it has concentrated on drilling for oil, where the commodity price is firmer. "The willingness to shift its capital expenditure to take advantage of the relative strength in commodity prices is a plus." The stock trades at a price to forward cash flow per share of four times.
In the materials sector, O'Brien likes the integrated fertilizer producer Potash Corp. of Saskatchewan Inc. POT. "Once again, these are long-life assets in a politically stable country." Also, the demand for grain "is less cyclical than for base metals." Finally, the industry is "oligopolistic and the individual players adopt a rational approach to pricing."
In keeping with his move to tilt his portfolio toward more defensive names earlier this year, O'Brien sold his holding in the global engineering and construction company SNC Lavalin Inc. SNC. "This company is leveraged to global economic growth, which has slowed, and it also has material exposure to the Middle East and North Africa, in particular to Libya, where there is political uncertainty."
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