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TransCanada Corporation: The Bear Case From a Bull

By Matthew DiLallo – Apr 20, 2017 at 12:00PM

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While the Canadian pipeline giant appears to have clearly visible near-term growth, there are a few things that could still go wrong.

TransCanada (TRP -2.15%) is in the midst of a major expansion phase that should see the company complete 23 billion Canadian dollars' worth of capital projects over the next several years. The company expects that those investments will fuel 8% to 10% annual dividend growth through 2020, with increases likely coming toward the upper end of that range. Meanwhile, the company anticipates achieving that growth while maintaining a solid financial footing.

That said, plans that look good on paper don't always work out so well when put into action. Take rival energy infrastructure giant Kinder Morgan (KMI -1.86%), which in late 2014, launched out on a path that it thought would provide investors with 10% annual dividend growth through 2020. Unfortunately, the company didn't get very far with that plan, abandoning it in less than a year after slashing the payout 75%.

While there are notable differences between where these two pipeline giants started out, there's still a risk that TransCanada might stumble in a similar way. Here are two things that could cause that to happen.

An oil pipeline.

Image source: Getty Images.

What will they protest next?

Underpinning TransCanada's ability to meet its ambitious growth plan is the on-time and on-budget completion of its capital projects. Two things that could cause the company problems are permitting delays or protests, which have hampered the pipeline sector over the past few years. TransCanada is no stranger to these issues after its Keystone XL project became the prime target of environmentalists a few years ago. That pipeline was ultimately rejected by the Obama administration, though the Trump administration recently gave it the green light.

However, that initial rejection seems to have emboldened those opposed to building more pipelines in North America as several other projects have experienced unexpected delays. Kinder Morgan, for example, has faced an uphill battle trying to get its Trans Mountain Pipeline expansion in Canada approved. Meanwhile, the company had to cancel two other projects that were in its initial backlog as a result of insurmountable issues, including permitting delays and pushback from local and environmental groups.

Meanwhile, pipeline projects by Energy Transfer Partners (ETP) and Williams Partners (NYSE: WPZ) have experienced similar issues. Energy Transfer faced intense opposition from environmental and Native American groups surrounding the river crossing of its Dakota Access Pipeline, which led to a denial of an essential permit when it was nearly 85% complete with the project, though it did recently finish construction. Meanwhile, Williams Partners had a gas pipeline in New York denied, and another one in Pennsylvania delayed due to environmental concerns.

Given the heightened scrutiny of pipeline projects in North America, there's a growing risk that one or more of TransCanada's expansion projects might face an unexpected delay. That could cause cost overruns, and it might affect the company's ability to hit its dividend growth target.

Finding the right way to fill the gap

Another potential stumbling block for TransCanada is obtaining the financing for all of its capital projects. As the chart below shows, the company needs to raise billions of dollars to fund its expansion program:

A chart showing the gap between TransCanada's capital resources and capital requirements.

Image source: TransCanada investor presentation. 

That slide also indicates that the company plans to finance the bulk of its capital requirements with fund generated from operations. That said, it still has a pretty healthy gap between cash flow and its capital needs. TransCanada intends to use a variety of sources to bridge that gap, including drop-down transactions with its MLP TC Pipelines (TCP), equity issuances, the sale of preferred shares and hybrid securities, and new debt. Given the company's currently top-notch balance sheet and A-rated credit, I don't think it will have any problem raising this money.

That said, the capital markets can change in a heartbeat, which was what upended Kinder Morgan's financing plans in late 2015. One area to keep an eye on is potential problems in obtaining bank funding for pipeline projects. Driving those concerns is what happened to Energy Transfer, which took out a $2.5 billion loan to finish construction of the Dakota Access project only to have opponents of the project pressure banks holding that debt to get it off their books. So far, two European banks have sold off tranches of this debt. Because of this, it might be harder for TransCanada to get financing for projects, especially if it once again becomes the center of attention either due to a decision to officially move forward with Keystone XL, or if another one of its projects causes a commotion.

Investor takeaway

On one hand, TransCanada looks like a compelling stock to own for the long term given that it has the projects underway to fuel 8% to 10% annual dividend growth over the next few years. However, while there's reasonable certainty to that plan, there's always a risk that things won't work out quite as expected, with permitting and financial problems being two things that might upend its plan. It's important to keep these potential pitfalls in mind because there is no sure thing when it comes to investing.

Matt DiLallo owns shares of Kinder Morgan and has the following options: short January 2018 $30 puts on Kinder Morgan and long January 2018 $30 calls on Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool has a disclosure policy.

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