TransCanada (TRP 0.33%) has an interesting problem these days. It has more expansion opportunities than it can fund. Because of that, the Canadian pipeline giant is looking for the best way to finance growth without harming its financial profile or giving away too much upside. The solution would enable the company to continue growing its 4.4%-yielding dividend at a healthy rate over the next few years.
A massive opportunity that's also a minor problem
TransCanada is in the middle of a significant expansion program. It has a jaw-dropping $36 billion Canadian ($27 billion) in capital projects under construction and another CA$20 billion ($15 billion) in development. Those expansions position the company to grow earnings by at least 16% over the next three years.
TransCanada generates loads of predictable cash flow and has a strong balance sheet, which will provide a substantial portion of its funding needs. However, it doesn't have enough internal capacity to cover its entire program, especially since it pays such a generous dividend and wants to maintain a strong financial profile. Because of that, the company needs to secure outside financing for a portion of its capital spending.
In the past, TransCanada routinely sold stock to help fund expansion projects as well as dropping down stakes in some of its pipelines to its MLP TC Pipelines (TCP). However, investors have soured on the constant dilution in the pipeline sector, which has taken stock sales off the table. On top of that, a regulatory rule change has hurt TC Pipelines. Because of that, additional dropdowns are also no longer an option. That is leading TransCanada to look at alternatives to help fund expansions while it continues growing its high-yield dividend.
Bridging an $8 billion gap
In 2019, TransCanada expects to spend about $8 billion on capital projects, including funding some of the construction on controversial large-scale pipelines Keystone XL and Coastal GasLink. It should generate several billion dollars of free cash flow after paying its dividend, which will cover a large portion of its funding needs. However, the company still has a sizable gap, even after agreeing to sell its Coolidge Generating Station for $465 million.
One option it's exploring is selling additional noncore assets. Reuters recently reported that TransCanada put its Columbia Midstream unit on the market, which could fetch $1 billion. Columbia operates four natural gas gathering systems in the Marcellus and Utica Shale regions. Selling this natural gas gathering business would match the approach of Canadian rival Enbridge (ENB -0.08%), which recently sold its Western Canadian gathering and processing assets as well as a U.S. gathering, processing, and transportation business. Those deals helped bolster Enbridge's balance sheet and bridge its funding gap.
In addition to selling cash-generating noncore assets, TransCanada is also considering bringing on partners to help finance some of its large-scale capital projects. The company has already hired advisers to find buyers for a majority stake in Coastal GasLink. If successful, TransCanada could sell between 51% to 75% of that project, which would offload a significant portion of its CA$6.2 billion ($4.7 billion) construction price tag. TransCanada has also said that it's considering bringing on funding partners for Keystone XL. In selling an interest in either project, TransCanada would not only offload a portion of the funding commitment but also some of the risk, which is significant since both pipelines face opposition from environmentalists and residents.
TransCanada's success in bridging its funding gap will enable the company to invest in high-return growth projects that will expand its earnings at a high rate. That would allow it to achieve its near-term dividend growth target of 8% to 10% annually through 2021 while also positioning it for continued growth beyond that time frame.
Walking a fine line
The upheaval in the energy sector in recent years has forced TransCanada to shift its financing strategy. The company needs to get creative in securing funding to build new projects so that it doesn't hurt its financial profile or dividend growth forecast. It's a tough balancing act, which is why investors need to keep a close eye on the company's progress since its success will directly affect how fast it can grow its dividend.