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TransCanada Corporation (NYSE:TRP) is a Canadian-based pipeline operator which manages a network of pipelines extending all over North America. TransCanada is also involved in power generation. TransCanada trades on the Toronto Stock Exchange (TSX) and the New York Stock Exchange (NYSE), under the ticker TRP.

TRP is part of the S&P/TSX60 index. TRP is a Canadian corporation and therefore pays its quarterly dividend in Canadian dollars. Foreign investors will thus be likely subjected to withholding tax.

Dividend Calendar

TRP pays a quarterly dividend. The dividends are generally declared in November (or late October), February, April, and July, and are generally paid in January, April, July, and October. TRP generally increases its quarterly dividend once a year, in February. In that sense, the last increase in February 2013 was of 4.5%. Normally, TRP should increase its quarterly dividend in the following weeks.

Dividend History

TRP has increased its quarterly dividend for 10 consecutive years, making TRP a dividend contender (between 10 and 24 years of consecutive dividend increases). The evolution of the annualized dividend and of its growth over the last ten years is presented in the graph below.

Overall, TRP has increased its dividend at a steady pace. Over the last 10 years, the annual dividend growth rate has generally remained between 5% and 7%. Though I like the overall stability and steadiness of the dividend growth, I'm worried by the all-too-clear declining growth rate since 2007.

As we will see below, I suspect the declining trend is likely to continue. That does not bode well of the future of TRP's dividend.

Dividend Analysis

In this section, I verify two important aspects of the dividend:

  1. Is the current dividend safe?
  2. Is the current dividend likely to grow?

Understandably, answering no to either one of these questions should mark the stock under consideration as being unsuitable for dividend investment purpose.

Is the current dividend safe?

To determine the safety of the dividend, I check the historical levels, the current level and the evolution of the payout ratio with respect to the earnings and, when relevant, with respect to the free cash flow. First, the evolution of the earnings, dividends, and payout ratios.

Then, the evolution of the free cash flow, dividends, and payout ratios.

Starting with the earnings, we can see that while the dividend has been growing, albeit at a declining rate, the earnings have not been growing much. In fact, since 2008, the earnings are even on a downtrend. Understandably, the combination of growing dividend and declining earnings has translated into an increasing payout ratio which is now dangerously near 100% and still rising.

In my view, this is unsustainable. Unless TRP starts growing its earnings again, I can't see how it will be able to not only maintain the current dividend but further increase it. As for the free cash flow, well there is not much to be said. TRP has been paying out more than its free cash flow in dividends since at least 2008.

Overall, I don't think the current dividend is safe.

Is the current dividend likely to grow?

In my view, the short answer is no. You can have one or two tough years in which the payout ratio is very high. However, when things return to normal, the payout should drop to a more sustainable level.

In the case of TRP, not only is the payout already near 100%, it is also on the rise. This is simply unsustainable over the long term. I don't see how TRP will be able to increase its dividend in a meaningful manner given its already high payout ratio and flat earnings.

Overall, I think the current dividend is likely to stop growing (or grow very slowly) in the foreseeable future.

Stock Valuation

Estimated Fair Values

To calculate a range of fair values, I calculate how much one share will return in cumulative dividends over the next 20 years, according to different scenarios, and adjusted for inflation.

For TRP, I've used the following inputs:

  • Share price: $49.00
  • Dividend rate: $1.84
  • Dividend growth rate:
    • Optimistic scenario: 5.0%
    • Realistic scenario: 4.0%
    • Pessimistic scenario: 3.0%
  • Inflation rate: 3.5%

The optimistic DGR generally corresponds to the 10-year average, while the realistic and pessimistic DGRs respectively correspond to 80% and 60% of the optimistic DGR. According to the above values, the range of estimated fair values for TRP varies from $35.16 (pessimistic) to $42.34 (optimistic) with a realistic value of $38.54. With a current share price around $49, TRP appears overvalued.

I've also calculated that the DGR would need to be 6.51% over the next 20 years to justify the current price of $49.00. Notably, a DGR of 6.51% is not only higher than the average DGR of the last 10 years, it is also way higher than the average earning growth rate over the last 10 years. Unless TRP starts to increase its dividend at a much faster pace, which I seriously doubt given the above numbers, I think TRP is currently overvalued, at least with respect to its dividend growth prospect.

At $49.00, I think TRP is overvalued as a dividend investment.

Estimated Cash Return

With the estimated cash return, I calculate how much cumulative dividends a fixed investment in the stock under consideration will return over a period of years. Estimated cash return values allow to compare dividend stocks with different yields and different growth rates.

For TRP, I've used the following inputs:

  • Initial investment: $1000
  • Current yield: 3.76%
  • Dividend growth rate:
    • Optimistic scenario: 5.0%
    • Realistic scenario: 4.0%
    • Pessimistic scenario: 3.0%

Notably, the DGRs are the same as the DGRs used for valuation.

I also compare the various estimated cash return values with the estimated cash return of a benchmark dividend stock having a yield of 3% and a dividend growth rate of 8% (e.g. Procter & Gamble (NYSE:PG) or Johnson & Johnson (NYSE:JNJ)).

This is interesting.

Despite the slightly higher yield (3.76%), the projected dividend growth rates are simply too low in all three scenarios to beat the benchmark stock. As we can see, even in the best of scenario, an investment in TRP would return significantly less money than a comparable investment in the benchmark stock. Enough said.

At the current price and yield, I think TRP would make a poor dividend investment with respect to the estimated cash return.

Conclusion

Before doing this analysis, my perception of TRP was good. From what I read, I thought it was a good dividend stock. Well, good thing I did do this analysis. Given the numbers above, I don't think TRP is a good dividend stock after all. At least not right now.

As we have seen, the stock is currently overvalued, the dividend is not safe (the current payout ratio is dangerously near 100% and growing), and the earnings are flat. In the best case scenario, TRP will be able to maintain its dividend and maybe continue to increase it but only symbolically. In the worst case scenario, TRP will be forced to cut its dividend to save money.

Either scenarios are bad scenarios from a dividend investor's perspective. What do you think?

Final recommendation: Don't buy TRP, the dividend is not safe.

Full Disclosure: I don't currently own shares of TRP. I don't intend to initiate a position in TRP within the next 72 hours.

Source: TransCanada Corporation - Dividend Fact Sheet Overview