TC Energy Corporation (TRP) is one of the largest pipeline operators in North America and one of the largest electrical utilities in Canada. This is a sector that has not performed very well in the capital markets this year as the exceptionally low crude oil price environment that has set in following the pandemic-related lockdowns has caused midstream companies to retrench and get sold off by investors en masse. We have also seen several of these companies cut their payouts to investors in response to the high cost of capital that they are now facing. TC Energy has not been immune to this but the company has definitely held up better than many of its peers have, which is a testament to the strength of its franchise. In fact, the company’s dividend has actually been steadily increasing all year, although this is due to the Canadian dollar increasing against the American currency. It has still performed much better than its peers though and combined with the stock price decline that the company has been suffering from, now yields an attractive 5.53%. Overall, then, this is a company that could be worth investigating.
About TC Energy Corporation
As mentioned in the introduction, TC Energy Corporation is one of the largest pipeline operators in North America. The company owns and operates 57,900 miles of natural gas pipelines that carry approximately 25% of the continent’s natural gas demand. The company also boasts 3,000 miles of liquids pipelines, which is nowhere near as large as the biggest operators in the sector but it still transports about 20% of the exports from the wealthy West Canadian Sedimentary Basin. Finally, TC Energy Corporation operates seven power plants in Canada producing a total of 4.2 gigawatts, which makes it one of the largest private electric utilities in Canada.
The fact that TC Energy operates as an electric utility is fairly novel, as very few midstream companies also generate electricity. It is also something that could give the company an advantage over some of its rivals. Over the past few years and especially this year, there has been a worldwide push for electrification in sectors such as transportation that have historically been dominated by fossil fuels for energy. This is one of the reasons why electric vehicle manufacturers such as Tesla (TSLA) have delivered such a strong performance this year and is driven by the belief that electricity is better for the environment than fossil fuels. It is expected that this push will ultimately extend to other areas as well such as the conversion of fossil fuels for home and industrial heating to electricity for that purpose. This is expected to cause the electricity demand of the North American continent to steadily grow over the coming years. This is shown here:
Source: International Energy Agency, TC Energy Corporation
One thing that we can clearly see above is that most of this demand growth is expected to be supplied by wind, solar, and natural gas. This is hardly surprising because one of the reasons for this electrification push is to reduce carbon emissions and these sources of power are generally cleaner than most others. There are a few problems with wind and solar power, however. The most significant of these is that both wind and solar are intermittent sources of power since they cannot produce if the wind is not blowing or the sun is not shining, respectively. Therefore, some source of power storage is needed to store surplus power during times when the facilities are operating and release it when they are not. There has been much thought around batteries for this purpose but there is in fact a better solution for those looking to reduce carbon emissions. That solution is pumped storage. Pumped storage is essentially a contained hydroelectric facility that consists of two pools of water at different elevations. Whenever there is surplus power in the grid, a pump moves water from the lower-elevation pool to the higher-elevation one. During times of high demand or when the solar and wind plants cannot provide enough energy, the water in the top pool is released and flows through a hydroelectric turbine into the bottom pool, thus generating electricity to make up the difference.
Source: UPS Battery Center
TC Energy is using this technology to enter into the rapidly growing energy storage market. The company is in the process of constructing two of these facilities in Canada at a cost of C$3.5 billion. The larger of the two by far is the one-gigawatt Ontario facility located near the shores of Lake Huron at the Canadian Army’s 4th Canadian Division Training Centre. The purpose of the project is to provide a flexible and clean energy storage solution to supplement the existing and planned renewable generation facilities in the province. Ontario is one of the most populated provinces in Canada, and this facility alone is quite large so its potential should be obvious. The project will also immediately reduce the carbon emissions of the province. This is because renewable facilities are currently being supplemented by fossil fuel power plants to overcome the problem of intermittent generation. This facility will be able to replace some of these fossil fuel plants and in so doing reduce greenhouse gas emissions by 490,000 tonnes annually. Unfortunately, regulators have not yet approved this facility but it would be surprising if they reject it once we consider the environmental benefits.
TC Energy also has more green credentials in Ontario in the form of the Bruce Power Plant. This is a 6.4-gigawatt nuclear facility that is 48.4%-owned by TC Energy. Admittedly, most people do not really consider nuclear power to be “clean” but as I pointed out in a recent article, nuclear power actually has lower lifecycle carbon emissions than even solar and the nuclear waste is not as much of an environmental problem as many people seem to think. This plant is one of the most important in Canada as it supplies about 30% of all of Ontario’s electricity consumption. It is also quite nice to see that all of the energy produced by this plant is currently under a very long-term power purchasing agreement. In fact, calling this a long-term contract is a bit of an understatement as it does not end until 2064. This agreement effectively ensures that the plant will have a steady source of revenues and cash flows, which is something that is always nice to those seeking a bit of security and stability.
As already mentioned, TC Energy also has one of the largest natural gas pipeline systems in the United States and Canada. This could also prove to be a source of growth for the company over the coming years. This is largely due to the increasing demand for natural gas that is accompanying the growing fears of climate change. As I have discussed in many previous articles, natural gas burns much cleaner than any other fossil fuel so one method being used to reduce carbon emissions is to retire old coal-fired power plants and convert them into much cleaner-burning fossil fuel ones. This trend has been going on in the United States for quite some time. As we can see here, back in 2008 natural gas produced approximately 21% of the nation’s power supply but today that figure is 38%, more than coal:
Source: Energy Information Administration, Range Resources Corporation (RRC)
Admittedly, the fact that natural gas prices have been incredibly low for most of the last decade of so has likely contributed to this trend as well but the environmental benefits much not be ignored. This trend is expected to continue. In fact, utilities throughout the United States have already announced the retirement of some of their aging coal or even nuclear plants that are expected to be replaced with natural gas plants. These planned retirements represent 44 gigawatts of capacity, which is only just a bit lower than the 53 gigawatts of capacity that was retired over the 2013-2018 period:
Source: Energy Information Administration, Range Resources Corporation
The obviously increasing use of natural gas will obviously boost the demand for natural gas. TC Energy Corporation is not a producer of natural gas but the growing demand for natural gas will still benefit it through the pipeline network. After all, pipelines operated by companies like TC Energy are the only realistic way to move natural gas from the fiels where it is pulled out of the ground to the end users. The fact that TC Energy has one of the largest pipeline networks on the continent in both the United States and Canada should ensure that it will obtain at least some of this business and thus see the gas volume that it transports regularly grow.
This is beneficial because of the business model that TC Energy has. A midstream company like this acts much like a toll road in that it charges a fee based upon the volume of natural gas that it transports and not upon the value of it. This provides the company a certain amount of insulation against natural gas fluctuations. Basically, its cash flows will not really go up or down just because commodity prices do, despite what the action of the stock in the market appears to imply. At this point, some readers might point out that the production of both oil and natural gas tend to decline when resource prices do, as what we saw happen following the price decline that accompanied the pandemic. TC Energy has a way around this problem, however. The company performs the transportation services that it provides to its customers under long-term contracts that include minimum volume commitments, which is a minimum volume of resources that the customer has to send through the pipeline or pay for anyway. These commitments effectively ensure that TC Energy has reasonably stable cash flows through any economic conditions. Indeed, TC Energy has only been minimally affected by the pandemic and expects to grow its EBITDA at an 8% compound annual growth rate over the 2015-2024 period:
Source: TC Energy Corporation
This cash flow growth is certainly something that is nice to see, particularly because most investors in midstream companies like this are attracted by the fairly large dividend yields that they typically boast. This is because it is ultimately cash flow that determines a company’s ability to pay out a dividend to its investors. This cash flow growth could ultimately result in dividend growth, which we will discuss in just a bit.
As just mentioned, TC Energy has a few avenues for growth going forward. The company is advancing in all of them. TC Energy is currently engaging in a C$37 billion capital growth program that encompasses all of its different lines of business.
As we can very clearly see, the majority of this spending is going to expand the company’s natural gas pipeline network. This does make some sense because natural gas offers a much greater potential for growth than its liquids business. As we have already discussed, natural gas is growing in importance for the generation of power. This is true not only in North America but also globally as other nations are seeing their own demand grow for much the same reasons as we are seeing in North America. There are only a few regions of the world that have the ability to increase their natural gas production, of which North America is one. This is expected to create a growing export industry in natural gas, which we have already begun to see happening. As we can see here, the demand for natural gas from these two sectors is expected to grow demand by 43 billion cubic feet per day over the next twenty years while the supply grows by 45 billion cubic feet per day to meet this demand:
As we can see, the growth in supply is expected to come from the West Canada Sedimentary Basin and Appalachia, both of which are very wealthy in terms of natural resources. TC Energy Corporation happens to be one of the largest pipeline operators in the Canadian Basin, which positions it well to benefit from these growing volumes and the company is moving to take advantage of that. One of the characteristics of natural gas pipelines is that they only have a finite capacity. Thus, the only real way for TC Energy to increase the amount of resources that it can carry is to construct new pipelines. This is exactly what the company is doing. TC Energy is spending about C$10.5 billion to construct new pipelines to increase the amount of gas that can be carried away from the West Canadian Sedimentary Basin:
The overwhelming majority of this spending is going to increase the capacity of the NGTL System, which makes a lot of sense. The NGTL System is the company’s gathering and transportation system for the basin. A gathering pipeline is a relatively short pipeline that grabs the natural gas from the well where it is produced and carries it to a long-haul pipeline that then moves it to its final destination. The expansion of this system should thus allow the company to support a higher number of wells, which will almost certainly appear as production grows. This will thus allow and enable TC Energy’s projected growth as it gathers more gas and gets compensated based on volumes.
One of the biggest reasons why investors are attracted to midstream companies like TC Energy is the fairly hefty dividend that they pay out. As of the time of writing, TC Energy boasts an appealing 5.53% dividend yield. This is substantially better than the 1.57% paid by the S&P 500 index but it is admittedly not as good as what some other midstream companies possess. Unlike some other midstream firms though, TC Energy Corporation has not cut its distribution this year. In fact, TC Energy has steadily grown its dividend since 2000, achieving a 7% compound annual growth rate over the period:
Source: TC Energy Corporation
It is important to note that this is in Canadian dollar terms and the dividend off of the U.S.-traded shares is somewhat more variable. It has generally increased over time though:
Source: Seeking Alpha
We can also see above that the company expects to increase its dividend by 8-10% in 2021 and then by 5-7% annually after that. This is certainly a reasonable rate that should ensure that our income from the company manages to outpace inflation. Naturally though, we should investigate the company’s ability to afford its dividend at present to evaluate the risks that this optimistic plan may not ultimately play out. One way that we can do this is by looking at a metric known as the free cash flow, which is the amount of cash left over from the company’s ordinary operations after it pays its bills and makes all necessary capital expenditures. In the third quarter of 2020, TC Energy had an operating cash flow of C$1.783 billion and total capital expenditures of C$2.063 billion, which gives the company a negative free cash flow of C$280 million. This is obviously not enough to pay any dividend, let alone the one that the company actually pays out. It is not exactly atypical for midstream companies to have negative free cash flow though since the capital-intensive nature of their businesses necessitates high costs that are frequently funded with debt. Thus, we can also look at the company’s operating cash flow to determine its ability to pay dividends. This figure was obviously more than enough to cover the C$800 million in dividends that the company pays out with just under C$1 billion left over to help fund its capital spending. The company can probably sustain this but I will confess that a positive free cash flow would be preferable since that means that it is not dependent on external financing.
In conclusion, TC Energy Corporation certainly has quite a few things to like here. The company has enjoyed much more stability than some of its American peers and has some growth prospects in both the emerging green energy economy and in traditional fossil fuels. The fact that the company owns an electric utility could also be rather appealing since this provides it with yet another very stable source of cash flow. Overall, this company looks like a reasonably good choice for someone seeking income and growth.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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