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Morningstar | TransCanada Reports Another Strong Quarter, but Our Long-Term Outlook Remains Unchanged

During the first quarter, narrow-moat TransCanada generated comparable earnings of CAD 987 million, or CAD 1.07 per share, compared with CAD 864 million, or CAD 0.98 per share, in the year-ago period. Comparable earnings surprised to the upside compared with our expectations, driven by a faster-than-expected ramp-up of the company’s U.S. natural gas growth projects. The company also reported distributable cash flow of CAD 1.6 billion, which was also above our expectations.

The Keystone XL remains in the legal system’s hands. In March, U.S. President Donald Trump rescinded his initial presidential permit on the pipeline and issued a new one for the project, hoping to bypass the legal challenges holding it up. With the new permit in hand, TransCanada is waiting on a court decision to begin construction. We think there is still time for construction to begin in the first half of this year, and we still expect the KXL to be placed into service by the end of 2021.

Despite the company’s outperformance during the quarter, we don’t see any changes to our long-term outlook. Accordingly, we are maintaining our CAD 70 fair value estimate and narrow moat rating. Due to changes in foreign currency rates, we are lowering our U.S. fair value estimate slightly to $52 from $53. TransCanada’s stock is up almost 30% during 2019, outperforming peers and the general market by a wide margin, but despite the rally, we still see over 10% upside in the 4-star name, coupled with a 4.8% and growing dividend.

With Canadian pipeline expansion expected to add 1.8 million barrels a day of new capacity in the near term, there is some uncertainty regarding the utilization of the legacy Keystone system. But investors should rest assured that the Keystone system will be fully utilized in the long term, with only a few quarters of minor underutilization. TransCanada secured commitments for 90% of the KXL capacity but will move 200 thousand bbl/d of commitments from the legacy Keystone system. However, that leaves more open spot capacity on the legacy system that serves the Midwest market. Eventually, the entire pipeline system will operate near full targeted capacity when Canada ramps its supply to our forecast levels and maximize returns on the project.

The market also continues to overlook the positive impact the CAD 38 billion growth portfolio will have on cash flows and the balance sheet. We think investors have placed 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. Once the Keystone XL is placed into service, we expect that coupled with various natural gas growth projects will generate CAD 3.5 billion in incremental EBITDA, which will support dividend growth and improve the balance sheet.

TransCanada’s current annual dividend stands at CAD 3 per share. While this lags peers, it's still attractive at a 4.8% yield and offers superior growth to Enbridge's dividend. We expect TransCanada to increase its dividend at 9% annually over the next five years while maintaining a comfortable coverage ratio that approaches 1.8 times and improving the balance sheet.

For a detailed look into Canadian crude market and pipeline trends, please refer to our January Energy Observer, "Pipelines Are Canada’s Lifelines."

For a deeper dive into TransCanada and what the market is missing about the stock, see our April 2018 Select report, "What the Market Is Missing on Keystone's Impact on TransCanada."