TransCanada aims big

We’ve long admired TransCanada Corp. for its high-quality operations and the predictable cash flows they generate.

The company is now building several new pipelines and power plants to spur its growth. The $22 billion cost of these projects nearly equals TransCanada’s market cap (the value of all its outstanding shares). But they should pay off for decades to come.

TRANSCANADA CORP. $36 (Toronto symbol TRP; Conservative Growth Portfolio, Utilities sector; Shares outstanding: 684.4 million; Market cap: $24.6 billion; Price-to-sales ratio: 2.6; Dividend yield: 4.4%; SI Rating: Above Average) operates a 60,000-kilometre pipeline network that pumps natural gas from Alberta to eastern Canada and the U.S. The company’s pipelines supply 20% of North America’s natural gas. In 2009, TransCanada’s pipelines accounted for 53% of its revenue and 73% of its earnings.

The remaining 47% of revenue and 27% of earnings come from the company’s electrical power plants. TransCanada owns or has stakes in 20 plants in Alberta, Ontario, Quebec and the northeastern U.S.

The company’s revenue rose 44.2%, from $6.1 billion in 2005 to $8.8 billion in 2007. Revenue fell 2.4%, to $8.6 billion, in 2008. However, revenue rose 4.0%, to $9.0 billion, in 2009, mainly because of the contributions of new power plants.

Despite the uneven revenue, earnings rose 57.9%, from $839 million in 2005 to $1.3 billion in 2009. TransCanada typically sells new common shares to pay for new facilities and pipelines. Because it now has more shares outstanding, earnings per share rose just 30.8%, from $1.72 in 2005 to $2.25 in 2008. In 2009, the company sold new shares worth $1.8 billion. As a result, its 2009 per-share earnings fell 9.8%, to $2.03. These figures exclude unusual items, such as investment gains and writedowns.

TransCanada is using the cash from the share sales to help pay for $22 billion in new projects. It has already spent $10 billion of these funds. It will spend the remaining $12 billion over the next four years.

Keystone could raise earnings by 40%

The Keystone pipeline is the biggest of these new projects. This pipeline will pump crude oil from Alberta’s oil sands to refineries in Illinois. The company has already spent $5 billion U.S. on this project, which will ultimately cost $12 billion U.S. The first phase should start up later this year.

The company plans to extend Keystone to the U.S. Gulf Coast in 2013. At full capacity, Keystone could add $1.5 billion U.S. to TransCanada’s annual gross profits of around $4.1 billion (Canadian).

The company is also building a $600-million U.S. natural-gas pipeline in Wyoming, which should start operating later this year. As well, TransCanada is spending $510 million (Canadian) on two pipelines that would pump natural gas from the Horn River basin in northeastern B.C. to TransCanada’s main Alberta system. One will begin operating in late 2010, and the other should be ready in 2012. Moreover, TransCanada’s new $320-million U.S. natural-gas pipeline in Mexico will begin operating in early 2011.

TransCanada has expanded its natural-gas storage business in the past few years. This business’s facilities let producers store their excess gas while they wait for higher selling prices. The company has contracts covering 75% of its storage capacity in 2010, and 51% in 2011.

Trans-Canada is also investing in new power projects: It is refurbishing two reactors at the Bruce nuclear-power station in Ontario (TransCanada owns 48.8% of these reactors). The company’s share of these costs is $2 billion. The reactors should start operating in 2011. As well, TransCanada is building a $350-million U.S. wind farm in Maine. However, government incentives should offset some of this project’s costs.

Still studying Alaskan pipeline

In addition to the projects it is currently working on, TransCanada is looking at building a 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.

An Alaskan pipeline would cost between $32 billion U.S. and $41 billion 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 project. That would help offset part of the construction costs. As well, the Alaskan government will contribute $500 million U.S.

TransCanada is now soliciting bids from potential gas shippers. If it decides to proceed, the new line could begin operating in 2020.

TransCanada’s balance sheet is sound, despite these big investments. Its long-term debt of $18 billion seems high, at 73% of its market cap. However, high debt loads are common for pipelines and other utilities. That’s because steady cash flows from their operations give them plenty of flexibility to pay interest costs and invest in new projects. Their high-quality assets also make it easier for them to issue new shares.

Ten years of rising dividends

The company’s steady cash flow has also let it steadily increase its dividend payments. TransCanada recently raised its dividend for the 10th straight year. The new annual rate of $1.60 a share, up 5.3% from $1.52, yields 4.4%.

TransCanada has enough capital for its new projects, so it has no plans to issue more common shares this year. The company should earn $2.13 a share in 2010. The stock trades at 16.9 times that figure.

TransCanada is a buy.