EUR 850.00 For Business Accounts Only

Morningstar | Another Strong Quarter for TransCanada, but Stock Still Remains Highly Undervalued

During the quarter, narrow-moat TransCanada generated comparable earnings of CAD 902 million, or CAD 1.00 per share, compared with CAD 614 million, CAD 0.70 per share, in the year-ago period. Comparable earnings surprised to the upside compared with our expectations, driven by better than-expected performance in the U.S. natural gas pipelines business; increased volumes on the Keystone Pipeline driven by excess Canadian crude supply; and lower U.S. income tax rates. The company also reported distributable cash flow of CAD 1.4 billion, slightly above our expectations. Higher distributable cash flow is attributed to the improvement in comparable earnings.

Furthermore, the board of directors declared its fourth quarterly dividend of CAD 0.69 per share, equivalent to CAD 2.76 per share on an annual basis. The dividend represents 10.4% growth compared with last year and is above the company's guidance of 8%-10% growth. Shares are currently yielding 5.6%, but management expects annual dividend increases in the upper end of the guidance through 2020, with an additional increase in 2021 that’s in line with the 8%-10% guidance. We expect next quarter’s dividend to reflect the target growth.

Subsequent to the quarter-end, the company announced a CAD 1.5 billion expansion of the NGTL system that is expected to be in service in 2022.

TransCanada remains on track with its plans to begin construction on the highly controversial Keystone XL next year, with an in-service date during early 2021. We think early 2021 remains optimistic, and we expect an in-service date in the back half of 2021.

We are maintaining our CAD 72 fair value estimate but lowering our U.S. estimate to $55 from $56 based on changes in foreign exchange rates. We are also maintaining our narrow-moat rating.

The stock is up 3% on the earnings release news. Despite the rally, we still see plenty of upside left for investors. With its 4-star rating and narrow moat, TransCanada's stock offers 40% upside and an attractive dividend yield. The market continues to overlook the positive impact the growth portfolio will have on cash flows and the balance sheet, and it places too much emphasis on less important outside factors such as the widening of the heavy oil discount, the Federal Energy Regulatory Commission's proposed tax regulations, and rising interest rates. The time is right for long-term investors to capitalize on the stock's considerable upside while collecting a steady stream of growing income.

For a deeper Dive into TransCanada and what the market is missing about the stock, please refer to our April Select report, "What the Market Is Missing on Keystone's Impact on TransCanada."

TransCanada's Keystone XL pipeline has been one of the most controversial pipeline proposals. The pipeline was shelved after not receiving a federal permit from President Barack Obama. But the tides turned with the election of Donald Trump. Shortly after being sworn into office, Trump extended presidential approval for the project.

On Nov. 20, 2017, the project cleared its final regulatory hurdle with approval from Nebraska. We expected Nebraska to rule in TransCanada's favor because of the high demand of heavy crude in U.S. Gulf Coast refineries, coupled with the economic upside for the U.S. economy associated with the pipeline project. We still expect that the project will take approximately 2.5 years to complete. As such, we expect the Keystone XL to be placed in service by 2021, providing the necessary long-term relief for western Canadian producers.

The 830,000-barrel-a day Keystone XL would originate in Hardisty, Alberta, and extend on a direct route to Steele City, Nebraska. Once in Nebraska, shipments are likely to be moved to Cushing, Oklahoma, and the U.S. Gulf Coast. The pipeline would add another alternative to extend oil sands production into the heavy oil preferred U.S. Gulf Coast. The project is expected to cost $8 billion.

For a detailed look into the Canadian crude and pipeline trends, please refer to our September Energy Observer, "Don't Overlook Oil Sands: Falling Costs and More Infrastructure Will Make Canadian Production Globally Competitive."