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My previous article on TC Energy Corporation (NYSE:TRP) was issued earlier this summer when I established a relatively neutral case for investing in TRP.
On the one hand, I saw some growth-accommodating aspects, such as an aggressive M&A strategy and a decent size of organic CapEx. On top of this, the fact that TRP had, starting from mid-2022, significantly underperformed the midstream index (by ~ 75%) created an opportunity to capture tangible gains from the price appreciation angle.
On the other hand, the relatively rich multiple, low yield, and debt-intensive balance sheet made me less optimistic about TRP, especially if the objective for investors is to pocket high and truly sustainable dividend streams.
If we look at the chart below, we will notice the considerable gains TRP has delivered since the publication of my previous article. Personally, I am not aware of any other large-cap midstream player that has registered returns at such a magnitude during this period.
Ycharts
Now, recently, TRP circulated its Q2 2024 earnings deck, which, in my opinion, renders the case slightly more attractive for defensive dividend investors. Allow me to explain.
Thesis review
All-in-all, the key metric - comparable EBITDA - came in materially above the result that was achieved in Q2, 2023. The incremental move was 9%, which is not significantly different from the overall dynamics we have seen in the midstream space (although it could be considered more on the higher end).
However, the question is what were the key drivers behind the surging unit price that we can see in the chart above. There are both structural and company-specific elements here.
In terms of the structural drivers, the fact that the prospects for natural gas consumption have improved has rendered clearly a massive benefit for TRP. Since TRP has one of the strongest biases on natural gas-related revenues (i.e., 89% of the total top-line generation), each positive data point that supports the natural gas market has a direct impact on the underlying business. Recently, constrained natural gas flows from Russia impacted by Ukraine entering Russian soil in combination with increasingly strengthening demand prospects for the natural gas regarding the expansion of AI-linked data centers contributed nicely to TRP's future cash flow projections.
Besides these important dynamics, there were several other critical data points that are definitely worth factoring into the investment case.
First, on a YTD basis, TRP has already placed circa $1.2 billion of new projects into service, which have already started contributing to the existing EBITDA generation. Yet, the better news is that the estimate for remaining assets that are planned to be put online this year is even bigger - at about $7 billion.
Second, as we look into the near future, the guidance provided by the Management sends an even more encouraging signal. The current assumption is that there will be an additional ~ $9 billion of projects put online over the course of 2025, which is a massive amount in the context of TRP's current market cap of just below $46 billion.
Third, during the quarter, TRP managed to successfully negotiate a 5-year revenue requirement settlement on NGTL with the effects extending from 2025 to 2029 (inclusive). From the EBITDA perspective, this is expected to bring in between $150 million to $200 million per annum of additional EBITDA (i.e., on top of the expected growth that is set to come from elements described in point #2 as well as from the periodic revenue bumps).
Fourth, TRP has recorded nice progress on the deleveraging front by already on a YTD basis divesting $2.6 billion of assets, which is only $400 million shy of the full-year target amount. The idea here is to receive some boost from incremental liquidity that could offset the pressure on the distributable cash flows before the new projects start generating revenues. On a net basis, the CapEx amount still exceeds the asset disposal amount by a notable margin.
Fifth, as a result of the aforementioned drivers, TRP is on track to reaching a debt-to-EBITDA of 4.75x by the end of 2024. This indicates a stabilization in the capital structure that should be followed by a gradual convergence to a more conservative debt level. Furthermore, the assumption is that starting from 2025, TRP will decrease its CapEx spending to $6 - $7 billion per year, which with EBITDA impact should enable TRP to de-risk the balance sheet going forward.
Finally, it is worth noting that Sean O'Donnell - Executive VP & CFO - provided a decent color in the recent earnings call on how strong the tailwinds are for TRP's business:
Second, we're seeing continued demand and reliability requirements from our utility customers. We have one of the largest natural gas storage systems in North America and that further bolsters energy reliability across the continent. Third, power generation demand is expected to increase significantly, driven by wide-scale electrification, coal-fired retirements, as well as emerging power needs from AI and data centers. As an example, we see around 300 data centers at various stages of development, 60% of which have proposed locations within 15 miles of our systems, namely Columbia.
Moreover, speaking of a bit longer-term prospects, within 15 miles (ca. 24 km) of TRP's Columbia and A&R systems 9 gigawatts of coal-fired generation is planned to be shut down in 2031. For TRP, this obviously implies an opportunity, where the Management has calculated that an additional 5 Bcf per day could be directed to covering the gap.
The bottom line
While currently TRP yields ~6.4% and has a rather high EV/EBITDA multiple of 14.2x (even though the leverage is quite notable), the future cash flow dynamics bode well for the Company.
Besides the secular tailwinds for natural gas demand, on a TRP level, we can see the effects of previously assumed leverage and funding of CapEx projects bearing already fruit in this and the upcoming year. The benefit here will be that TRP will start to recognize additional EBITDA generation finally, which in combination with the reduced CapEx agenda should help TRP to de-risk the balance going forward. We have to remember also that higher EBITDA will automatically push down the EV/EBITDA multiple as well as allow TRP to distribute higher dividends, especially considering that the CapEx volumes are set to decline.
The risk that remains open is that the balance sheet is still relatively debt-saturated. However, given that CapEx will go down (and this is something that the Management can directly influence) and the EBITDA growth is already partly secured, I just do not see how the financial risk could increase from here.
As a result of this, I am upgrading my TC Energy Corporation thesis to buy.
