Big new projects will pay off for decades

TransCanada and Canadian Utilities are both working on major new projects. Despite the huge size of these undertakings, their overall risk is low. That’s because government regulators will let the companies pass along most of the costs to their customers in the form of higher rates. This should let both firms keep paying their current dividends, or raise them.

ATCO owns a majority interest in Canadian Utilities, so it also stands to profit from these projects.

As well, Finning should benefit by selling construction equipment and repair services to TransCanada and Canadian Utilities.

TRANSCANADA CORP. $33 (Toronto symbol TRP; Conservative Growth Portfolio, Utilities sector; Shares outstanding: 624 million; Market cap: $20.6 billion; Price-to-sales ratio: 2.3; SI Rating: Above Average) operates a 59,000-kilometre pipeline network that pumps natural gas from Alberta to eastern Canada and the U.S. It also owns or invests in 20 electrical power plants.

To diversify its operations, TransCanada is building the $12-billion U.S. Keystone pipeline, which will pump crude oil from Alberta’s oil sands to refineries in Illinois. TransCanada has already signed contracts with oil shippers at an average term of 18 years. In total, these deals represent 83% of Keystone’s capacity.

The new pipeline’s first phase should start operating early next year. TransCanada plans to extend Keystone to the U.S. Gulf Coast by 2012.

The company has also won an exclusive license to build a new $26-billion U.S. pipeline that will pump natural gas from Alaska’s north shore to Alberta. From there, TransCanada would ship the Alaskan gas through its existing pipelines to markets in Canada and the U.S.

ExxonMobil Corp. (New York symbol XOM), which owns major untapped gas fields in northern Alaska, has agreed to become a minority partner in this pipeline, which could begin operating in 2018.

These projects will probably add to TransCanada’s $17.5-billion long-term debt, which is equal to 85% of its market cap.

However, high debt loads are common for utility companies. That’s because their steady cash flows give them plenty of room to absorb the interest costs and invest in growth projects. Their high-quality assets also make it easier for them to issue new equity, as TransCanada did last June when it sold $1.8 billion of new common shares.

The dilution caused by these extra shares will limit TransCanada’s per-share earnings growth to $2.07 a share this year. The stock trades at a reasonable 15.9 times that estimate. The $1.52 dividend yields 4.6%.

TransCanada is a buy.

CANADIAN UTILITIES LTD. (Toronto symbols CU [class A non-voting] $39 and CU.X [class B voting] $39; Income Portfolio, Utilities sector; Shares outstanding: 125.6 million; Market cap: $4.9 billion; Price-to-sales ratio: 1.8; SI Rating: Above Average) distributes electricity and natural gas in Alberta. It also operates power plants in other parts of Canada, and in the U.K. and Australia.

In August, Canadian Utilities received preliminary approval from the Alberta government to build and operate a new high-voltage transmission line between Edmonton and Calgary. Final approval for this project should come later this year. The line is part of a wider plan to make Alberta’s electricity grid more reliable.

This new line will cost $1.65 billion, and will probably take several years to complete. To put this in context, Canadian Utilities earned $73.5 million, or $0.59 a share, in the three months ended June 30, 2009.

Unlike TransCanada, Canadian Utilities is working on improving its existing pipelines instead of building new ones.

However, the two companies’ pipeline networks are interconnected at certain points, and share other physical assets. So, it’s possible that Canadian Utilities could indirectly profit from higher traffic on TransCanada’s network. As well, TransCanada will probably use more of Canadian Utilities’ gas-storage facilities as it increases its capacity.

Canadian Utilities will probably earn $2.95 a share this year. The stock trades at 13.2 times that figure. The $1.41 dividend yields 3.6%.

Canadian Utilities is a buy. The more liquid class “A” non-voting shares are the better choice.