It’s pretty easy to figure out why the pipeline sector is so popular with investors.
Pipelines have a lot of things investors look for. Since they tend to enter into contracts with energy producers, this ensures a steady stream of revenue. Costs are largely upfront in nature, ensuring steady profits once the pipeline becomes operational. And thanks to these steady profits, pipelines tend to give investors consistent dividends.
There are several pipeline companies in Canada, and plenty more in the U.S. Which one should investors choose? I took a closer look at the two largest in Canada, TransCanada Corporation (TSX:TRP)(NYSE:TRP) and Enbridge Inc. (TSX:ENB)(NYSE:ENB) and found TransCanada to be the superior investment. Here are three reasons why.
It’s cheaper
Because of the large amounts of depreciation that comes with the pipeline business, valuing these companies on a price-to-earnings basis doesn’t make a whole lot of sense. And since so much of the value of these companies consists of debt, we have to factor that in as well. Thus, I’ll use the enterprise value to EBITDA ratio (earnings before interest, taxes, amortization, and depreciation) as the main valuation tool.
The results aren’t even close. Enbridge’s enterprise value to EBITDA ratio is 22.9, meaning investors are getting a return of about 4% before the company pays interest, taxes, or deducts depreciation. TransCanada investors are paying just 10.9 times EBITDA for their shares, a valuation that’s less than half as expensive as Enbridge. TransCanada investors get an EBITDA margin of about 9%, which is a much better value than its more expensive peer.
Better dividend
Getting consistent dividends is important for most investors, and especially so for folks who put their money to work in pipeline sector. While both Enbridge and TransCanada have good dividends, it’s obvious TransCanada offers the better deal for folks concerned with getting income today.
TransCanada’s yield is a very generous 4.8%, which trounces Enbridge and its 3.5% dividend. An investor who put $10,000 in both companies would be looking at $480 annually from TransCanada, and just $350 annually from Enbridge. That’s a big difference for somebody looking for income.
Investors looking for a little extra yield from Enbridge can check out the company’s preferred shares. The series 13 preferred shares (under the ticker symbol ENB.PF.E) currently yield just under 6%, which is pretty attractive compared with traditional income instruments, or even compared with the common shares.
Potential catalysts
Both Enbridge and TransCanada are waiting on regulators to give approval to mega-projects. Enbridge is currently working on its Northern Gateway pipeline, while TransCanada has two projects ready to go, Keystone XL and Energy East.
I’m not going to spend much time speculating on the chances for each of these projects to actually be approved. All I know is that transporting crude via pipelines is a better solution than the available alternatives, so governments are likely to approve at least one of TransCanada’s big growth projects, if not both.
One of the reasons why TransCanada shares are so much cheaper than Enbridge’s is because investors are discounting the chances of TransCanada’s two big growth projects ever happening. Thus, when either project does actually get approved, investors should see the share price lift as the market digests the potential increase in cash flow.
TransCanada is much cheaper than Enbridge, has a better dividend, and has a couple of interesting catalysts to propel the stock higher if Energy East or Keystone XL get approved. For those reasons, it’s a pretty easy choice. Investors should prefer TransCanada over Enbridge.
