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Morningstar | TransCanada Green Lights Coastal GasLink; Raising Fair Value Estimate for the Undervalued Stock

Narrow-moat TransCanada announced that it is moving forward with the Coastal GasLink pipeline, which will transport 2 bcf/d of natural gas from the Montney formation in western Canada to the newly approved LNG Canada export facility. The pipeline will cost CAD 6.2 billion to build, but TransCanada is exploring funding options for a possible joint venture. We expect the pipeline to be placed into service by the beginning of 2024, and it is fully underpinned by 25-year take-or-pay contracts.

The CAD 40 billion LNG Canada project received the green light on Oct. 1. The project will export liquefied natural gas from the west coast of Canada to Asian markets, where we expect demand for LNG to increase from approximately 20 billion cubic feet per day to almost 50 bcf/d by 2025.

We think this is a good move for TransCanada as it positions the company to add to its impressive growth portfolio with a fully secured pipeline that positions the company to take advantage of increasing Asian LNG demand. Accordingly, we are slightly raising our fair value estimate to $56 (CAD 72) from our previous estimate of $54 (CAD 71). Additionally, Coastal GasLink will provide another commercially secured growth project to underpin dividend growth.

The stock is up 1% on the news of the project, and we still see plenty of upside. With its 4-star rating and narrow moat, TransCanada's stock offers 35% 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 due to 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."