Why I Am Staying Away From TransCanada Corporation

TransCanada Corporation’s (NYSE:TRP)(TSX:TRP) quarterly results came in below estimates both on the top and bottom line. Should you hold on to your shares or look for better alternatives?

| More on:
The Motley Fool

We do not worry about short term hits or misses here at Motley Fool Canada, but there are long-term challenges for TransCanada Corporation (NYSE: TRP)(TSX: TRP) that pose a problem, in my opinion, and warrant a deeper look.

Future profitability exposed to “mega-projects”

The company has a $38 billion capital spending program for the following decade. While this sounds good on paper, the problem is that 45% of these investments are linked to two controversial projects. Both the Keystone XL pipeline in the United States and the Energy East Pipeline project in Canada are under scrutiny by their respective governmental agencies and are at risk of additional regulatory delays.

Seeing that the market is forward-looking, any delays to both projects could bring the value of the company lower because the eventual cash flows expected will be discounted in later years. Many of the company’s other projects are in the early stages of development, with the majority of the upside potential to be expected later in the decade.

While TransCanada does have many more projects in the pipeline and a well-diversified revenue stream, there is cause for concern, as over 40% of its capex is tied to government regulation.

Steep valuation

When purchasing securities, it’s important not to overpay for your investment. Let’s look at the valuation of TransCanada at the moment. Currently, the price to EBITDA ratio for the company is 8.38, while the 10-year historical average is closer to 6.20. That is a difference of 35% to the upside. The price-to-book value metric corroborates this thesis of overvaluation with a 10-year average of 1.96 and a current value of 2.30. The dividend has not followed this increase, standing close to its average of 3.9 at 3.5% yield.

When asked about the difference between investment and speculation, the legendary investor and father of value investing, Benjamin Graham, said this: “An investment operation is one in which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.’”

As a value investor, I do not like those numbers as they seem to indicate a high level of optimism from investors regarding future revenue that isn’t justified, in my opinion.

Better alternatives

If you do want exposure to the pipeline sector, there are better alternatives in Canada, like ShawCor Ltd. (TSX: SCL), which I wrote about earlier this week. If you prefer a pure play on energy transportation, Enbridge Inc (TSX: ENB) (NYSE: ENB) might be a better alternative to TransCanada. While Enbridge is not yielding the same amount of dividend — coming in at only 2.6% — its projects are much more certain than TransCanada’s are. Better yet, Enbridge has managed to increase its dividend every year for the past 19 years.

Enbridge has $36 billion of commercially secured projects through to 2017 and is currently growing earnings at a 10%-12% compounded annual growth rate. Most of its projects are scheduled to be completed in the short term, putting less discounting on its share valuation.

Investors can continue to expect earnings growth of that magnitude in the future, along with the appropriate dividend increase.

Foolish takeaway

TransCanada is operating in a sector that is in full expansion at the moment, but while one can be optimistic about the prospects of the industry, there are specific risks associated with such capital-intensive sectors. Considering the valuation currently placed on TransCanada and its projects, I would much prefer owning Enbrigde for my dividend energy play. Better yet, why not get some additional growth with ShawCor instead?

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor François Denault has no position in any stocks mentioned.

More on Investing

Start line on the highway
Investing

Canadian Small-Caps: Where the Next Generation of Winners Will Come From

Bank strategists see the TSX outperforming the S&P 500 in 2025, powered by Canadian small-cap stocks.

Read more »

Piggy bank with word TFSA for tax-free savings accounts.
Stock Market

3 Canadian Stocks to Consider Adding to Your TFSA in 2025

Here's why Canadian investors can consider holding quality growth stocks such as Magellan Aerospace and Sylogist in a TFSA.

Read more »

clock time
Investing

It’s Time to Buy: 1 Canadian Stock That Hasn’t Been This Cheap in Years

Alimentation Couche-Tard (TSX:ATD) is a great Canadian stock that's close to the cheapest it's been in a while.

Read more »

Investing

Missing Out Is Costly: Why the Smartest Investors Keep Buying Canadian Stocks

Here's why you should continue to include a decent allocation to domestic equities.

Read more »

tsx today
Stock Market

TSX Today: What to Watch for in Stocks on Wednesday, February 12

TSX investors will keep a close watch on the U.S. inflation report and corporate earnings as today’s trading session unfolds.

Read more »

Canadian flag
Dividend Stocks

1 Magnificent Canadian Dividend Stock Down 8% to Hold for Decades

Do you want some dividends with those returns? Then buy this stock while it's down.

Read more »

A worker overlooks an oil refinery plant.
Energy Stocks

Suncor Energy: Buy, Sell, or Hold in 2025?

Let's dive into the risks and catalysts underpinning Suncor Energy (TSX:SU) right now and see if this stock is worth…

Read more »

A plant grows from coins.
Stocks for Beginners

Rebalancing Your Portfolio for 2025? 3 Growth Stocks to Consider

There's no shortage of great growth stocks to consider for your portfolio. Here's a look at three that could provide…

Read more »