The Globe and Mail
September 27, 2012
Martin Mittelstaedt

TransCanada: prized yields vs. politics

TransCanada Corp. presents something of a love-hate proposition for investors. Love the rising dividend, hate the politics swirling around the company.

The pipeline giant’s stock yields 3.9 per cent and has the wonderful attribute of an increasing payout. Since 2007, the dividend has risen 5 per cent a year, a pace that has endeared it to yield-hungry investors and some analysts. UBS Securities, for instance, has TransCanada in its elite, 12-stock portfolio of “dividend growers.”

TransCanada, however, isn’t a stodgy old utility from days of yore, when a predictable rate of return from pipelines or other regulated assets delivered stable cash inflows.

Its prospects for future earnings and dividend growth have a lot of moving parts to contend with, among them the current bare-knuckled brawl playing out at National Energy Board hearings between TransCanada, and natural gas producers and Alberta industrial gas users, over tariffs on its Mainline pipe that moves gas from Alberta to eastern Canada. The Mainline, now running at about half capacity, may also be vulnerable to further usage erosion due to cheap U.S. gas imports into Ontario.

TransCanada is also smack-dab in the centre of the biggest environmental battle in the United States, the highly contentious Keystone XL pipeline that would move crude from Alberta’s oil sands to the U.S. Gulf Coast.

If that weren’t enough, the company, through partial ownership of the Bruce nuclear generating complex in Ontario, is exposed to aging reactors that in the past have been cantankerous, as well as the province’s highly politicized electric power sector.

One of the biggest wild cards is Keystone. Many analysts assume that when the U.S. election is out of the way, the company will receive a presidential permit for its revised line, possibly as early as the first quarter of next year. At that point, either a new Republican administration would give the line its blessing, or Barack Obama, should he win and no longer need to have to mollify environmentally sensitive voters, would do the same.

But opponents insist an approval isn’t a done deal.

“The Keystone XL tar sands pipeline, now more than ever, is not in the public interest, and we cannot prejudge what the new environmental review process and national interest determination will find,” cautioned Susan Casey-Lefkowitz, a spokesperson for the Natural Resources Defense Council, an environmental advocacy group based in New York.

TransCanada is about to start receiving revenue from its partly owned Bruce units 1 and 2, following an expensive refurbishment of the two reactors. Costs were estimated at $2.75-billion in 2005, but have nearly doubled to $4.9-billion. TransCanada estimates its share at $2.4-billion.

The refurbishment works out to about $3,000 per kilowatt hour of electricity capacity, or the amount of power that would run 10 100-watt light bulbs for an hour. New natural gas plants only cost about $1,000/kWh of capacity.

In the United States, some utility analysts are questioning whether it makes economic sense to repair aging reactors when gas is so cheap, but TransCanada said earlier this year that the assets position it “well for the future.”

Critics say Ontario has a reputation for granting overly generous, long-term price contracts to electricity producers. The province “is obviously paying way too much per kWh for a project that was forecast to cost $2.75-billion,” said Jack Gibbons, chairman of the Ontario Clean Air Alliance.

Given the controversies, there is a divided sell-side analyst community on TransCanada, a surprise considering investing in a utility and projecting its price trend would normally be an easier call than in more volatile sectors. A tally by Bloomberg shows seven “buys,” eight “holds,” and two “sells,” with the projected 12-month price target from a low of $42 to a high of $52.

One of the bears, Patrick Kenny at National Bank Financial, thinks the 2013 profit outlook is softening due to lower power prices and start-up delays at Bruce.

Consequently, he figures consensus earnings for next year are too high and the stock should trade down to $42.50. Given that Keystone XL isn’t approved, he’s withholding $2.50 a share from his target price.

But over at RBC Dominion Securities, Robert Kwan has a bullish $51 target, which includes $4 of speculative value if TransCanada is able to convert part of its underused Mainline from gas to oil. He’s also assuming the company will be able to raise 2013 earnings by 13 per cent over this year’s projected profits.