The challenges facing TransCanada

The biggest concern is cost and regulatory issues tied to Keystone XL and Energy East projects, says equity analyst David McColl.

Ashley Redmond 7 October, 2014 | 5:00PM David McColl

 

 

Ashley Redmond: I'm Ashley Redmond for Morningstar.ca. I am here with equity analyst Dave McColl who covers the big oil and gas companies in Canada for us. David, thanks so much for joining me.

David McColl: Thanks for having me.

Redmond: David you cover TransCanada. It trades under the ticker TRP on the TSX and it’s one of the largest natural gas pipeline businesses in North America. Unfortunately their Q2 earnings came in slightly under what we expected. David what are you expecting from TransCanada going forward?

McColl: Well, one of the challenges that TransCanada faces is the direction of its pipelines. They are moving gas out of Alberta into the U.S., but we've seen a complete shift in North America [because] there is lots of gas being produced in the Marcellus—that’s in the Northeast U.S.—and that’s pushing back Canadian gas. That helped put pressure on its earnings. So, what we are seeing going forward is TransCanada’s strategy to really drop down or sell most of its U.S. natural gas pipelines to its master limited partnership. That’s interesting because that could potentially add $6 to $8 per share in evaluation if they are able to sell its natural gas businesses in the U.S.

Redmond: Where do you see risks to their growth including Keystone XL and Energy East?

McColl: Most people would think about the risk being tied to its natural gas pipelines and selling them down. We think the risk continues in Canada and it continues with Keystone XL, which as I am sure people are aware is effectively waiting for a Presidential permit, six years and running now in the regulatory process. Energy East is the idea to convert part of its gas pipeline to oil and provide an export opportunity for Canadian light and heavy oil out of the Montreal area and out of St John. The challenges there are related to cost. We see regulatory issues in Canada holding it up and even aboriginal issues which are starting to come to the forefront from a recent court decision in BC.

Redmond: Recently there has been an activist investor rumour with TransCanada, can you tell us a little bit about that and if possible offer some comments on it?

McColl: Yeah, rumours are always difficult to talk about especially in the Canadian space where typically we require about a 10% interest stake that a company has to have before it is disclosed. In Canada we think there is somebody who is involved, maybe not at that 10% threshold, and ideas have been proposed such as dropping down its natural gas pipelines to the MLP (master limited partnership) and that’s been TransCanada's idea. So, it's hard for somebody to take credit for that.

We've also heard ideas of splitting out its power from its pipeline division. What we don’t really like about that is that it doesn’t add a lot of potential value to TransCanada. It may add a few dollars per share and the risk you get from that—in our mind doesn’t make sense—you are pulling off assets which tend to be countercyclical with each other. So, while one business is weak the other tends to be stronger. We think there are a lot of rumours that people should watch for and [possibly] higher dividends on the horizon, but we caution not to jump on the rumour.

Redmond: Okay. And what does this mean overall for their growth and for their moat as well?

McColl: I don’t necessarily think it's going to detract too much from its growth. TransCanada has a great profile of growth projects extending out almost to a decade when we think about its liquefied gas projects, pipelines and oil pipelines. In terms of some of the other challenges that it could face [I think] the biggest issue for TransCanada deals with if we see a sell of its assets, a split that we think impacts its evaluation somewhat negatively.

Redmond: We'll be watching for that. Thanks so much David.

McColl: Great thank you.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
TC Energy Corp64.23 CAD0.99

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Ashley Redmond

Ashley Redmond  Ashley Redmond is a Vancouver-based freelance writer.