TC Energy's logo on a smartphone in an illustration, Dec. 4, 2021.DADO RUVIC/Reuters
TC Energy Corp. (TRP-T) has recently fallen out of favour with investors, but we believe this would be the right time to add the energy infrastructure company to any investment portfolio.
TC Energy transports oil and natural gas through 90,000 kilometres of pipeline across North America. It delivers energy to millions of people, connecting growing supply in the most prolific production regions of the continent to refineries and key end-markets.
The company has a very stable business. So what happened, and why are we looking at it now?
As part of its growth strategy, TC Energy is building the Coastal Gaslink pipeline, which will transport gas from northeast B.C. to a coastal facility for export to Asia. As with every large and complicated construction project, there is always the possibility of cost overruns and other mishaps. Sure enough, in November, 2022, the company announced that the final bill for this project would be higher than the previous estimate of $11.2-billion.
The stock market reacted with considerable disapproval to this announcement, sending shares tumbling to $53 from $66. On Feb. 1, management updated their guidance for the Coastal Gaslink project, to an estimate of $14.5-billion. The shares dropped a dramatic 7.5 per cent that day. They closed Thursday at $55.48, far below their recent high of $75 in June, 2022.
The Coastal Gaslink pipeline is facing cost pressures that include shortages of skilled labour, contractor disputes and even some unexpected weather events. Fortunately, the likelihood of more cost increases is negligible given that the project is now more than 83 per cent complete. The target date for completion is the end of this year.
A fundamental component of our investment process at Goodreid is to ensure that we invest in quality companies. In analyzing the quality of TC Energy, we must first consider its network of oil and gas distribution assets throughout North America.
This network of infrastructure is virtually impossible to replicate. It is extremely difficult to build a pipeline for many reasons: government regulation, environmental concerns, higher input costs, labour issues and lobbying by special interest groups. Subsequently, when a pipeline is finally constructed and operational, there is a legitimate “economic moat” protecting its business model. Warren Buffett describes an economic moat as “a business’s ability to maintain its competitive advantages over its competitors in order to protect its long-term profits and market share.” Just like a medieval castle, the moat serves to protect those inside the fortress from outsiders.
TC Energy’s revenue stream is built on long-term contracts with stable cash flows. It is relatively simple to organize the capital structure efficiently, and pay out a large proportion of earnings in dividends. The company offers an impressive dividend yield of 6.5 per cent, which management has raised every year for more than 20 years. That is real commitment to your dividend.
Another key metric to quality is profitability. When we consider the five-year average return-on-equity, or ROE, for TC Energy, it is an impressive 16 per cent. In 2022 that number jumped to a remarkable 20 per cent. These are strong numbers relative to the long-term average ROE for the TSX at 12 per cent, and 14 per cent for the S&P/500. Meanwhile, TC has a solid and stable capital structure with a prudent amount of debt. It has sufficient liquidity to meet its interest obligations, and there is considerable room available on the company’s credit lines.
What about valuation? As a business that is exposed to volatile swings in commodity prices, TC Energy’s share price has experienced volatility over the years. Volatility is a function, not a flaw of investing. It provides plenty of opportunity for the astute investor to purchase shares at a margin of safety when they are out of favour.
There are a number of ways to approach TC’s valuation.
First, the stock trades at 12.7 times trailing earnings. This compares attractively to the S&P/TSX Composite Index at a 13.3 times its earnings multiple. When compared with peers, TC continues to look attractive. Enbridge Inc. trades at 18.4 times trailing earnings, despite a similar business model. Even smaller peer Pembina Pipeline Corp. trades at 16.6 times earnings. South of the border, U.S.-listed Kinder Morgan Inc., which is a large energy distribution company, trades at a considerably more expensive 15.7 times earnings.
Lastly, consider TC’s current multiple to its own historic trading range. Over the past decade the average multiple was 18.3 times earnings. Over the past five years that multiple was a more reasonable 14.8 times. So the take-away here is that TC’s multiple is attractive not just relative to it’s peers, or the TSX average, but also to it’s own historic trading range.
The opportunity then is for shares to experience “reversion to the mean” and rise to their prior multiple, driving the share price back toward $75. This move represents about a 39-per-cent increase, and if you add your 6.5-per-cent dividend yield, this implies a 45.5-per-cent return. This compares very favourably with the average annual long-term equity market return of 7 per cent – a return matched by TC’s dividend yield alone.
Robert Gill is senior vice-president and Canadian portfolio manager at Goodreid Investment Counsel Corp.
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