Despite the negative momentum in TransCanada’s (TRP) stock, we see an attractive entry point for long-term investors. With its 4-star rating and narrow economic moat, TransCanada remains one our top picks in the Canadian energy sector, which looks to be fairly valued overall. Our fair value estimate assumes that the Keystone XL pipeline will be placed into service during the second half of 2021, the impact of the Federal Energy Regulatory Commission’s regulations are insignificant to TransCanada’s operations, the company will add CAD 2.8 billion in annual incremental EBITDA from its natural gas expansion projects, and leverage will fall significantly once the investment cycle concludes.
We think investors are not seeing TransCanada’s big picture and are too narrowly focused on outside factors and temporarily higher leverage. If we use assumptions that reflect the market’s expectations-- lower Keystone utilization levels, lower revenue on natural gas pipelines associated with the FERC announcement, and higher dividend yield spreads compared with historical levels--we get a fair value estimate that approximates today’s share price. However, we think the market is overlooking what will be higher-than-expected utilization for the Keystone XL, dividend growth, the minor impact of the FERC’s proposed regulation on TransCanada, falling leverage, and the company’s natural gas portfolio.
Joe Gemino, CPA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.