Which Canadian Energy Stocks Will Raise Dividends in 2024?

Ruth Saldanha: Hello and welcome to our limited time series the Morningstar Canada Stocks Outlook for 2024 where we will speak with Morningstar equity analysts to find out what they expect in the new year. Today, Stephen Ellis of Morningstar Research Services is here to discuss Canadian energy, a mainstay of the Canadian economy. Now some themes to watch for in this space include the start of the Trans Mountain Expansion and Canadian LNG exports. What does all of this mean for dividends? Let's ask him. Stephen, thank you so much for being here today.

Stephen Ellis: Thank you so much for having me.

Canadian Energy Stock Performance in 2023

Saldanha: So, let's start by talking about how 2023 went. Was Canadian energy in line with your expectations?

Ellis: So, I would say it did a little bit better than I thought. I think entering 2023 we were primarily concerned about the market insight being weaker, particularly against the lower oil and gas prices. And what ended up actually happening is we are pleasantly surprised in that the LPG markets, LPG export markets were actually a little bit tighter than we thought, primarily because Chinese feedstock demand for a lot of new plants coming online really pulled demand forward. And so, the prices for NGLs were much higher and the Canadian energy firms in general would benefit from those high prices and wider spreads. So, I would say it was a very positive experience for Canadian energy in 2023 for sure.

Key Themes for Canadian Energy Stocks in 2024

Saldanha: In 2024 what are some of the key themes that investors should watch?

Ellis: Well, I think the key theme for me is going to be looking at some of the major M&A transactions. You know, I think first we're going to be looking at the Enbridge (ENB) transaction where it's acquired the three utilities from Dominion Energy (D). So that's expected to close in 2024. Now that's a $19 billion Canadian deal, so certainly it's a significant transaction. And Enbridge just today released announced that they have sold off roughly $3 billion in assets to Pembina (PPL) to help fund that transaction. So that is a really good thing for Enbridge because it will help reduce the amount of leverage that they have on their balance sheet, which was a big concern for investors when Enbridge announced that purchase from Dominion Energy. So, we're definitely having some good news on that.

So, I think the idea there with the transaction is that the utility earnings will ultimately create a more as we might expect utility like profile for Enbridge and the earnings will certainly be de-risked. So that's a good thing for that one. The other thing I would want to point out too is that on the Pembina side it is a really good thing because they're adding assets with their Alliance Pipeline that they know very well that they've had in place for several years. And it is a very reasonable valuation as well, which is definitely an issue for Pembina in the past given that historically they've had both paid for deals in the past. So, I think this is definitely a very positive thing that we'll be looking for in the space next year.

Risks to Watch For in Canadian Energy Stocks

Saldanha: On the other hand, what are some of the risks that you're considering?

Ellis: So, the risks, I think the big thing has to be the Trans Mountain Expansion. You know, that's coming online in early '24. The major risk there really is, what's the impact going to be on Enbridge oil volumes, mainline oil volumes. Because it is seen as the primary competitor, which was recently set up as a way to move crude barrels to Canadian coasts for export. And certainly, dramatically shorten the time frame to move Canadian barrels to export as opposed to moving them all the way down to the U.S. Gulf Coast. So definitely a really good thing for Canada, but it hasn't necessarily played out that way for a number of reasons so far, as we probably know that the pipeline is substantially overrun. It's currently costing approximately $31 billion to build. So, the interesting thing is how that can impact Enbridge. And, Enbridge has really been, you know, really, I think, thoughtful about how it will address that threat. They've been, I think, adding a lot of expansions to their U.S. pipeline network. And that has been really to serve the idea that more attractive that Enbridge can make its U.S. pipeline network to compete with Trans Mountain. The more options Enbridge can offer Canadian producers to maintain barrels on their pipeline, the less attractive the Trans Mountain Expansion is going to be. So far, we think Enbridge has done a really good job. They have consistently reduced the number of barrels that they expect to be lost to Trans Mountain over the last 18 months. And so, we think there is really good shape on that. But we will have to see how it all plays out.

Which Canadian Energy Stocks Will Raise Dividends in 2024?

Saldanha: The one thing that Canadian investors are obsessed with is dividend. So, let's talk about dividends a little bit. What do you think of Canadian energy dividends for 2024?

Ellis: So the big Canadian dividends will really be Enbridge and TC Energy (TRP). You know, we expect dividends to grow for those two firms about 3%, 4% in 2024. So that's probably a good outcome. You know, certainly not as fast as it has been in prior years. But I think the emphasis from both firms have been, you know, they really want to maintain sustainable, solid dividend growth. They know the importance of dividends for their investors and how critical those are to their investor groups. So, they are really trying to manage the idea that they have substantial CapEx needs in the business, particularly as you see with the M&A that's occurring. And also, the fact that they want to position themselves well for low carbon and renewable opportunities in the future. So, they're kind of balancing between, hey, we have these growing opportunities on the business side, but we also want to maintain a fair return to investors. So, I think they're striking that balance pretty well. And I think the emphasis really is again, and making sure that they're sustainable, supported by the balance sheet, supported by the cash flows instead of risking a dividend cut in the future.

Morningstar’s Top Canadian Energy Stock Pick

Saldanha: Finally, what's your top Canadian energy pick for 2024?

Ellis: So, the one that I'm really interested in is TC Energy. And TC Energy, I think, has been historically priced at a premium. And was not necessarily being undervalued. But I think today it is. And I think what makes it really interesting in my opinion is the fact that investors are very concerned about leverage. TC Energy has made a lot of progress on that, they just closed $5 billion Canadian asset sale. And they have another $3 billion asset sale on deck. That is primarily going to be, at least my guess, would be particularly Mexican assets, Mexican gas assets, which I think would be a certainly a good deal for them. But the other thing that I think makes it really interesting is just spinning off the liquid business in the second half of 2024.

Now, I don't know about you, but when I see spin-offs, I love spin-offs. Spin-offs are really interesting for me because there's a great opportunity for the fact that it could be really undervalued. So, we don't know if it's going to be undervalued yet because we don't have all the details in place. But the opportunity set is very interesting because it's very clear from how TC Energy talks about the liquids business that it would be (starved of) capital. And the fact that now the business can be separate, run by a separate management team, know that opportunities with a lot more capital to work at really high returns. And that does seem like that's going to be the case at this point. So, I think we have an opportunity to have undervalued stock and potentially a really interesting spin-off. So, I think it's definitely something to keep an eye on.

Saldanha: Great, thank you so much for joining us today with your perspective, Stephen.

Ellis: Yeah, no problem. Thank you for having me.

Saldanha: For Morningstar, I'm Ruth Saldanha.