Enbridge, TransCanada: Pipeline Companies Offering Safety and Growth

Is it really possible to have your cake and eat it too? Can you really find a stock that offers very “visible” earnings, yet with some decent upside? I think so, and here are two of them…..

Enbridge (ENB) and TransCanada (TRP) are often interchanged with each other, but they are relatively different in terms of how they generate their respective overall earnings. However, both of them offer an investor with a good chance for Capital appreciation, a decent (and growing) dividend, and good downside protection in the event of another downturn in the market.

Enbridge

Enbridge is often considered to be the more “growth” play between the two companies, and therefore usually carries a slightly higher P/E Multiple than TransCanada. The main business that most people know Enbridge for is its “Liquid... Pipelines (namely Crude Oil). Its existing pipelines mainly bring down Crude from the Western Canadian Sedimentary Basin to the Central / Eastern USA, and into Eastern Canada. These pipelines produce steady cash flow and very safe earnings.

To bolster the existing network, the company is adding several additional lines, including the Alberta Clipper, a massive 1000 mile pipeline to bring down extra Crude from the Alberta Oil Sands. This part of the business has produced incredible steady earnings growth of about 10% annually since 1995.

In addition, Enbridge also gets considerable earnings from Nat Gas Pipelines, through its Investments Arm (Enbridge Income Fund) and through an extensive Natural Gas Distribution business in Eastern Canada, with almost 2 Million customers.

Enbridge has rarely ever been considered a cheap stock, so you’ll have to pay up for it. It trades at about 15x expected 2010 Earnings, and rarely falls down below 14x Forward earnings. However, this is down from its traditional multiple of about 20x, and offers a decent long-term entry point. With a 4% dividend, good growth prospects (analysts forecast about a 10% Annual growth rate for the next 5 years) and a strong defensive nature, it is a good long term hold. Expect it to return to its traditional multiples when Credit markets ease up, with a 12 month target price of close to $45 to $48 CDN.

TransCanada

TransCanada has a strong interest in the Pipeline world, but also has some interests in the Power Generation space. TransCanada owns and operates over 35000 miles of Pipelines throughout Canada, the US and Mexico. Primarily, they move Natural Gas from Western Canada to the Great Lakes area and Eastern Canada. Recently, the company has begun to move Oil through much of the U.S., including an extension down to the Houston / Louisiana areas.

At a recent Annual meeting, the CEO provided further insight into two massive upcoming projects (Alaska and Mackenzie). While they are both a long way away from completion, they both provide strong earnings growth visibility for many years. Finally, the Keystone project (which is an Oil Pipeline expansion from Alberta to Houston) is expected to be fully operational in the next 3 years.

In terms of Power Generation, TransCanada has a strong mix of Power Generation stations in Alberta, Ontario and the NE USA. Its recent purchase of Ravenswood (which generates about 25% of the Power in the New York City area), has helped to bolster this area. Finally, TransCanada is now the 2nd largest provider of Natural Gas Storage in North America, with a storage capability of over 350 BCF.

Like Enbridge, it is rare to find TransCanada selling at true “Fire sale” prices. The stock has traditionally traded in and around the 18x Forward earnings range in the past. Today it can be picked up for about 13x its forecasted 2010 earnings, which makes this one priced at an attractive entry point.

A concern to be watched with TRP is that some analysts were concerned about its ability to raise capital for some of its many projects. This concern seems to have been eased somewhat, by the fact that the company has a strong balance sheet and it was able to raise over $5B late in 2008 (which does help to show the confidence that many in the market have in this stock). With a dividend just shy of 5%, and solid (but steady) growth in the future, it isn’t unreasonable that TRP could break through its 52 week high of $40.71 CDN in the next 12 months.

Disclosure: Currently am Long on TRP (It is my 5th largest position at 5.4% of my portfolio). I do not currently own Enbridge, but am looking to pick it up around the $35 CDN range.

Comments

[Darrell:]

I have owned TRP for longer than I want to remember; I reinvest the dividends and it is a core holding of mine.

May 24 01:49 PM

[Al in Oregon:]

Let me get this straight. TRP "has a strong balance sheet" with a D/E ratio of 1.65?

May 24 02:39 PM

[Alan Young:]

Many pipeline companies pay dividends in the range of 8-12%: e.g., TCLP, TLP, KMP. It would be useful to explain why you would pick these two, which pay a much more modest yield.

May 24 04:44 PM

[Larry Belle...:]

Thanks for reading, Everyone.

In terms of its overall Balance sheet, I can see what you are referring to, and I probably should have clarified that statement. What I was referring more to was their ability to fund current projects without having to go to the market for more capital, at least for the foreseeable futre. I do admit, their debt load is higher than I would like, but with their steady cash flow and good visibility, it isn't a concern for me.

In terms of other ones, I try to avoid thinks that may affect my personal tax situation (meaning that as a Canadian, I don't want to get involved in situations such as US Limited Partnerships, as they add to an already complex return.....doesn't mean that they are bad companies by any stretch). This would rule out TCLP / TLP from my list.

As for Kinder Morgan, there is nothing wrong with them, especially if you are looking for more a pure play in Mid-Stream, as they focus more on Pipelines and NG storage.

Personally, I like the added diversity that Enbridge (Retail Distribution of Nat Gas) and TransCanada (Power Generation) have.

As a disclosure, I have owned Kinder Morgan on at least 2 occasions in the past, but do not own it now. No position on the other two stocks.

May 24 05:23 PM

[naidle:]

If we're in an inflationary environment are regulated utitilities such as Enbridge really a great idea?

I like both companies if held long enough (say 10 years) but I doubt most on this board have that type of patience.

May 25 10:40 AM

[Larry Belle...:]

Naidle -- Excellent point. However, there are two ways that you can look at that argument....On the negative side, High inflationary times tend to boost up Interest rates, and since these companies (along with most Utilities) have to borrow significant amounts of money, their interest costs can hurt earnings. As well, their Dividends can look a bit less attractive when you can earn a high yield in your Savings account.

However, there is also a positive side to these companies in High Inflationary times. Their previous debt does become less in "Real Terms" during inflationary times. As well, many economists feel that it makes sense to own Hard Assets (such as Real Estate, Gold and Pipelines) during inflationary times, as the value of these assets tends to keep up with Inflation. As well, because much of their income is regulated, they generally can increase rates to keep up with Inflation, as per their contracts.

It will be difficult to know which is the right way to go, if we do have the inflation that I suspect that we will get. These companies weren't the same entities during the last time that we had High Inflation (the early 80's), so there isn't a huge track record.

I personally have a portfolio that is geared for this (namely TIPS, Gold and Oil Companies, all of which should do well).

Great point! Thanks for reading
Larry

May 25 12:06 PM

[Al in Oregon:]

My original reason for reading this piece was my interest in investments geared toward the inflationary environment. And not only has the economy crashed, I also suspect growth will be grudging in the years to come given the anti-business/high tax sentiment reigning in Washington. For all these reasons I’ve become attracted to high-dividend stocks in foreign currencies that can sustain their payouts.

If inflation pops in the coming months as seems likely, dividends and hard assets denominated in foreign currencies should hold their value - or even jump as capital seeks safe havens. At least that’s my thinking. Canadian oils fall under that category. Following that line of thought, recently I’ve been buying foreign telecoms with high yields, low P/E’s, relatively low debt (thus my original question), and good profitability. They are:

TKC 6.7 P/E, 6% yield, .15 D/E
TLK 12.9 P/E, 5.9% yield, .55 D/E
TSP 9.4 P/E, 8.8% yield, .33 D/E
SKM 9.1 P/E, 8.7% yield, .32 D/E

On the Canadian oils theme I owned ECA, TLM, and HSE.TO but got out with the run up of the last couple of months. I’m not sure we’re not in for another deflationary bout in the short term. I’m looking to get back in. An added attraction to Canadian oils arises out of the possibility of a Washington-inflicted carbon tax or cap and trade penalty on US oils. I’m not sure what the impact of a carbon tax would be on Canadian pipelines. Would it shut down US petroleum consumption and reduce pipeline volumes?

May 25 01:39 PM

[Larry Belle...:]

Al -- Interesting points.....here's my take:

You've listed three very different Canadian Energy Companies. EnCana (ECA) is a great place for long-term growth, as they have a strong position in Nat Gas, and a growing Oil Sands/refinery play. I expect them to one day split off into two companies, as was planned a while back. Talisman (TLM) is also a balanced play with good assets in many parts of the world, including an interesting play in Shales in NY State. I also like their SE Asia Assets (Vietnam, as I recall), and they have always traded at a lower Price to Cash flow (must be still because of the hangover of their Sudan experience, maybe because of Jim Buckee leaving, who knows). Finally, Husky is more of an integrated, yielding play (although EnCana does pay a nice yield too), with their strong Retail and CardLock plays. I like all three and have owned them at different times (disclosure -- Long only on EnCana, no current position in the other two).

If you are looking for Canadian Energy Infrastructure plays, you may also want to look at Keyera Facilities (KEY.UN on Toronto). It does a lot of work in the Mid Stream Nat Gas processing. It is a Canadian Income trust, so be sure to find out how that affects your tax situation (generally, their distributions are taxed more like Interest income, rather than dividends). Disclosure -- No position, but looking at it closer.

Being that I am a Sales Director for a Wireless Solutions company (and have been in the Wireless space for over a decade), I can speak somewhat intelligently on the industry. However, I haven't done a lot of research on any of those (but will now....thanks for pointing them out). I currently own Telefonica (more for the yield, and for their Latin America growth exposure). I have also owned America Movil, France Telecom and Verizon in the past year.

Finally, as for the Petroleum consumption, it's hard to say. An important part to remember is that there is an overall decline in much of the US Domestic Oil production (except for the Shales), so I suspect that even if there is a dwindling demand, the production may fall off faster, leading to a sustained growth in pipeline rates/volumes. I think that the reduction in Oil usage in the US will be more gradual (people still have the same commutes, and Obama's increased Mileage standards don't even kick in for at least 5 years, as I recall).

Great questions...
Larry

May 25 11:56 PM

[Albert Meyer:]

Al in Oregon... I'm with you on TKC, TLK and SKM.. you can add CHL and TEF to the list.

TRP is a standout company with one of the best CEO's around. Utilities are always highly leveraged, because of the collateral value of their assets and predictable recurring cash flows. TRP manages its balance sheet very well.


On May 25 01:39 PM Al in Oregon wrote:
They are:
>
> TKC 6.7 P/E, 6% yield, .15 D/E
> TLK 12.9 P/E, 5.9% yield, .55 D/E
> TSP 9.4 P/E, 8.8% yield, .33 D/E
> SKM 9.1 P/E, 8.7% yield, .32 D/E

May 26 09:09 AM

[naidle:]

Thanks for the detailed response. It's a good point regarding inflation and the value of debt especially when speaking about TransCanada.

You could do a lot worse than TRP but I'm still in the worried camp as of today.


On May 25 12:06 PM Larry Bellehumeur wrote:

> Naidle -- Excellent point. However, there are two ways that you
> can look at that argument....On the negative side, High inflationary
> times tend to boost up Interest rates, and since these companies
> (along with most Utilities) have to borrow significant amounts of
> money, their interest costs can hurt earnings. As well, their Dividends
> can look a bit less attractive when you can earn a high yield in
> your Savings account.
>
> However, there is also a positive side to these companies in High
> Inflationary times. Their previous debt does become less in "Real
> Terms" during inflationary times. As well, many economists feel
> that it makes sense to own Hard Assets (such as Real Estate, Gold
> and Pipelines) during inflationary times, as the value of these assets
> tends to keep up with Inflation. As well, because much of their
> income is regulated, they generally can increase rates to keep up
> with Inflation, as per their contracts.
>
> It will be difficult to know which is the right way to go, if we
> do have the inflation that I suspect that we will get. These companies
> weren't the same entities during the last time that we had High Inflation
> (the early 80's), so there isn't a huge track record.
>
> I personally have a portfolio that is geared for this (namely TIPS,
> Gold and Oil Companies, all of which should do well).
>
> Great point! Thanks for reading
> Larry

Jun 09 01:13 AM