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Investors with a more bullish view on natural gas prices might want to look to TransCanada Corp. (TRP) as a derivative play on the commodity. Higher natural gas prices would provide earnings upside for the company due to an expected improvement in power prices, particularly in Alberta, according to RBC Capital Markets analyst Robert Kwan.

He noted that in the past week, several coal plant outages combined with the recent uptick in gas prices, has pushed Alberta power prices above an average of C$100 MW per hour. Alberta power prices troughed in the second quarter and RBC anticipates an improvement going forward.

“A recovery in natural gas prices, which sets the marginal cost of power, and the improvement in economic activity are all positive factors expected to drive power prices higher,” Mr. Kwan said in research note.

TransCanada is moving forward with its C$17-billion capital plan through 2011, but is also targeting annual capex of roughly C$3-billion to pursue longer-term growth opportunities. These projects include the Zephyr and Chinook electric transmission lines moving power from Montana and Wyoming to Nevada. With a preliminary cost estimate of US$6-billion and a potential in-service date of 2014, Mr. Kwan estimates they could contribute almost C30¢ share to earnings.

While TransCanada is expected to see near-term weakness in its 2009 earnings and only modest growth in 2010 due to relatively low power prices, the analyst thinks the shares represent good long-term value with nearer-term growth driven by the commissioning of new projects like the Keystone pipeline. He told clients that the shares are trading at the lower end of the historical P/E range during the past give years.

“We believe that the low valuation multiple and the underperformance versus the broader market limits the downside in the stock,” the analyst said.

RBC rates TransCanada Outperform with a C$38 price target, representing upside of roughly 12%.

Source: TransCanada: Long-Term Value, Natural Gas Investment