Financial Jungle

Just because the financial sector is ruing Bear Sterns’s stunning collapse doesn’t mean all dividend investors are in dire straits. Smart investors who are surviving this bear market are diversifying into sectors that don’t correlate with the financial sector. Something like the largest pipeline operator in the country, TransCanada (TRP), should fit the bill, because it’s partially immune to both subprime and recession.

TransCanada is a huge conglomerate, but its 2 family jewels are pipelines and energy. Its “network of more than 59,000 kilometres (36,500 miles) of pipeline taps into virtually all major gas supply basins in North America.” The company is also one of North America’s largest providers of gas storage, and a key power plant operator with interests in approximately 7,700 megawatts of power generation.

The pipeline stocks tend to pour in vast amounts of positive cash, but they’re not traditionally known for their growth. However, things are about to change with a glut of crude and natural gas coming on steam in and around Alberta over the next 6 or 7 years. The problem is that the real demand for energy isn’t in Alberta; it’s in Southen U.S. And if crude gets clogged up in Alberta, all producers suffer a phenomenon known as apportionment, where a shortage of pipelines is preventing cruel oil from being shipped to places where it can command top dollars. With producers and refineries crying at both ends of the pipe, companies like TransCanada and Enbridge can come in to relieve the congestion. And to profit handsomely, of course.

Pipelines, are what some people call, a business with strong economic moats. Building a pipeline is tough work. It’s notoriously expensive, complex, and you must wait maybe 2 or 3 years to reap the rewards. On top of that, management must jump through many regulatory hoops, and duke it out with relentless oppositions such as First Nations, farmers, environmentalists and workers unions. The bright side is that all these Mount Everest tall hurdles tend to chase away rookie entrants wishing to duplicate the service. That’s great for long-term shareholders looking to protect their dividend streams.

Here is a map from TransCanada’s annual report showing off their pipelines which span from Canada down to Mexico. Over at the lower right (1) is the recently acquired $3.4 billion 17,000km long ANR gas pipeline system. Next is a 50% ownership in the $5.2 billion Keystone Pipeline (2), which is TransCanada’s venture into the oil pipeline business. This 3,500 km pipeline is currently under construction, and is expected to deliver 590,000 barrels of crude per day. Operation will begin in late 2009. North Central Corridor (3) is a $983 million expansion to the existing Alberta System gas pipeline. The two dotted lines (4) are the proposed Northern Pipelines: the Mackenzie Gas Pipeline and the Alaska Pipeline.

We always think of pipeline stocks as slow moving mammoths, but the company is firing on all cylinders with its numerous growth initiatives, such as the Keystone projects, northern pipelines and expansion to their Alberta system. TransCanada, along with arch-rival EnBridge, are in the most prosperous economical environment possible despite US slipping into a recession. Back-of-the-envelope math suggests that TransCanada is investing at least $11 billion in key pipeline and power projects between 2007 and 2010. (I know I’m underestimating this.) That’s a staggering figure relative to TRP’s $20 billion market cap. In 2008 alone, management forecasts overall capital spending to be $2.9 billion.

Here’s an image of their power plants and gas storages. The key excitement in this area is the refurbishment of Bruce A Units 1 and 2 (9) which is expected to add another 19% of additional megawatt of output in 2010. A couple of other initiatives include the Portlands Energy Centre (11) and Halton Hills Generating Station (10) generating 550MW and 683 MV respectively when they’re complete.

Valuation

At 16 PE, TransCanada isn’t exactly a bargain when compared to the 13.9 historical average. (Financials are still the cheapest.) But the business is investing heavily these days to accelerate revenue, cash flow and earning growths. Given their improved growth profile, I believe buying at historical average PE is a reasonably attractive entry price, or ~$33 with 4.3+% dividend yield. TransCanada closed higher on Thursday at $38.06. I’m keeping an eye on this one.

Disclosure: I have positions in TransCanada, EnBridge and Inter Pipeline Fund.