TransCanada (TRP) current holding report - SELL

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This report has been downloaded from the KSU Student Managed Investment Fund. LLC archives, and was prepared by student analysts; and any

opinions contained herein are solely the opinions of those analysts. Information contained herein, including but not limited to research, valuations, calculations, estimates and any other material or sources, is

believed to be reliable, however its accuracy and completeness is not warranted or guaranteed, and past performance is not indicative of future results. These

materials are provided for informational purposes only and should not be used or construed as an offer to sell or a solicitation of an offer to buy any security. The

KSU Student Managed Investment Fund, LLC. is not acting as, nor is it registered as an investment adviser.

Natural Gas Pipelines Coverage TRP’s pipeline system (e.g see fig. 1) in North America is one of the premiere pipeline systems in the world. TRP fully owns 84%, or 57,000 km of its pipeline network, which virtually connects every major natural gas supply basins and markets. TRP’s largest pipeline system, the NGTL system, spans over 24,525 km and delivers natural gas within Alberta and B.C and connects with the Canadian Mainline system,

KSU Student Managed Investment Fund LLC.

Jerry Vieux

[email protected] Senior Analyst - Energy

Target Range – $49.75 - $53.36 Current Price – $33.15

September 27, 2015

Current Holding

TransCanada Corporation (TRP)

Rating: Reduce Position

Ticker (NYSE)

TRP

Industry

Average

Current Price $31.14 Target Range

$49.75 - $53.36 -

Market cap 23.04 -

Trailing P/E 17.8 32.3

GM 72.7% -

ROE 10.16% 7.4

Beta 0.94 - Dividend Yield 4.93% .6

Price/Book 1.76

2.3

(Review in Bloomberg)

Company Profile TransCanada Corporation is one of the largest North American energy company headquartered in Calgary, Alberta. TRP focuses on natural gas transmissions and power investments. The company operates in three main segments: Natural Gas Pipelines, Liquid Pipelines, and Energy Generation. The Natural Gas Pipelines is the leading segment with total revenue of $4.913 billion in 2014, followed by the Energy Generation and Liquid Pipelines segments, which generated $3.725 billion and $1.547 billion respectively. TRP currently has over 68, 000 kilometers of natural gas pipelines and 4, 250 km of liquid pipelines with gas storage capacity exceeding 368 billion cubic feet (bcf). TRP has 19 power generation facilities in North America generating 10,900 megawatts. TRP currently operates in seven Canadian provinces, 35 U.S states, and Mexico.

Quick Facts Purchase Date: 12/06/2013 Purchase Price: $43.76 Current Price: $31.14, as 9/30/15, 11:40pm Overall % Gain/Loss: -28.84%

Management Chairman of the Board, CEO since 2008: John Martin President of, CEO since 2008: John Milligan Chief Financial Officer, Executive VP since 2014: Robin Washington Upper-level management ages range from 49-81 yrs.

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Foothills system, and other pipelines. The ANR Pipeline, the second largest pipeline with a network of 15,109 km, transports natural gas from supply basin markets throughout the mid-west and south to the Gulf of Mexico. It also provides 250 Bcf of regulated underground natural gas storage service. Other substantial pipelines network includes: Canadian Mainline (14,114 km), Great Lakes (3,404 km) and Gas Transmission Northwest (2,178 km). TRP’s extensive network coverage has allowed the company to serve over 80% of the Canadian demand and 15% of the U.S.

Liquid Pipelines TRP’s primary growth focus remains its liquids pipelines system, also known as the Keystone Pipeline system. The Keystone Pipeline System is a four-phase 4,247 km pipeline system that transports crude oil from the Western Canadian Sedimentary Basin in Alberta to markets in the American Midwest and the U.S Gulf Coast. The Keystone Pipeline Phase I and the Keystone-Cushing Extension (Phase II) was completed in June 2010 and February 2011 respectively. The Gulf Coast Extension (Phase III) is projected to be complete by the end of the year. The existing phases of the Keystone Pipeline System transports 600,000 barrels of crude oil per day. The completion of the controversial Keystone XL, the last phase of the pipeline system, would ramp up total capacity by 830,000 barrels per day. Since July 2010, the completed phases of the Keystone Pipeline System have safely transported over 830 million barrels of crude oil from Canada to the U.S Markets. The Keystone Pipeline System’s operations contributed more than $1 billion dollar in TRP’s EBITDA in 2014.

Energy Generation TRP is the largest private-sector power company in Canada. Currently TRP has 19 power generation facilities generating close to 11,000 Megawatts of diversified energy which includes nuclear, hydro, wind and solar. TRP’s energy business is primarily located in Canada (Ontario and Alberta) and in the Northeastern of the United States. TRP’s Ravenswood Generation Station can generate more than 20% of New York City’s electricity. In 2014, TRP’s energy business generated over $ 1.3 billion in EBITDA and the company has located growth opportunities in Alberta where energy demand continues to grow. In addition, more than 800 MW of coal-fired generation is expected to come offline at the end of the decade.

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(Fig. 1)

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Management Russ K Girling (Chief Investment Officer) – Mr. Girling has been the CEO of TRP since its appointment in July 2010. Mr. Girling served as CFO, CFO and Executive Vice-President prior to becoming CEO. He has built a strong reputation in the Energy sector throughout his career. He held management positions in other reputable energy companies, notably Suncor (SU) and Northridge Petroleum Marketing (Now CXY).

Barry Jackson (Chair of the Board) – Mr. Jackson has served as the chair of TRP’s Board of Directors since 2002. He has held senior management positions in the oil and gas industry since 1974.

Karl Johannson (Executive Vice-President and President, Natural Gas Pipelines) – Mr. Johannson is responsible for TRP’s natural gas pipelines and regulated natural gas storage in Canada, the U.S, and Mexico. He joined TRP in 1990. Mr. Johannson has been credited for the profitability of TRP’s Alberta System, Canadian Mainline, and Foothills System.

Recent News

TRP says it plans to eliminate 20% of its senior leadership positions, as it seeks to lower costs.

TRP says the reduction in management position will partly be achieved by not replacing retiring workers. This reduction follows 185 job cuts the company announced in June. TRP is trying to reduce costs to deliver on C$46B of major projects by 2020, including the Keystone XL pipeline.

Saskatchewan government says rejection of Keystone XL pipeline seems likely

One of the biggest backers of the Keystone XL pipeline is acknowledging that the project is

likely doomed to fail. The Saskatchewan government is expecting Keystone's demise after

American Democratic presidential contender Hillary Clinton said she opposes it.

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Keystone XL The Keystone XL project (Fig. 2) is a massive 1,897 km, 36-inch diameter crude oil pipeline expanding from Hardisty, Alberta to Steele City, Nebraska. In addition to transporting crude oil from Canada, the Keystone XL pipeline will allow U.S oil producers in the Bakken Region of Montana and North Dakota access to refining markets in the Midwest and the U.S Gulf Coast and hence contribute to the growth of crude oil production in the United States. Currently, TRP accounts for 20 % of transportation of crude oil in North America. The approval of the Keystone XL would boost TRP’s transportation business tremendously. Oil output from Western Canada is forecasted to more than double to 4.8 million barrels a day by 2030 according to the Canadian Association of Petroleum.

(Fig. 2)

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The progress of Keystone XL was “stopped” after the U.S Senate failed to override the President Obama’s veto of the bill approving the construction of the pipeline. The final vote was 62-37 in favor of the bill, but short of the two-thirds required to override the President’s veto. According to president Obama, building the Keystone pipeline has the potential to jeopardize America’s clean energy future and international leadership in climate change. Besides the oil spill risks, which were a major issue during the President’s first term with the Gulf Mexico incident in 2010, the fact that Keystone XL will deliver “oil sands” is a major concern. Processing the gunk of oil sands is more energy intensive, making it the most carbon intensive fuels on earth. Additionally, the extraction of oil sands can potentially emits 17% more greenhouse gas than regular oil. The delay over regulatory review has increased the cost of Keystone XL by more than 48% from $5.4 billion to over $ 8 billion. Shippers agreed to pay 75% of additional costs up to $ 8 billion. Additional costs beyond that amount will be evenly split. Despite the increasing costs, TRP and the shippers remain fully committed to Keystone XL. They believe that Keystone XL will remain the cheapest mean of crude oil transportation. The construction Pipeline continues to remain a political debate. While Republicans view the project as a tool that can bring up thousands of jobs and decrease the U.S dependence oil dependence from less stable countries, Democrats fear it can bring an environmental calamity to the country. Both parties’ positions have been reiterated with recent comments of presidential candidates Jeb Bush and Hillary Clinton. I believe that the construction of Keystone XL will be ultimately approved given its economical contributions and overwhelming support. In addition, the State department environmental review concluded that the construction of the pipeline would be insignificant because the sand oils will be produced in the end anyways. However, I do not expect this approval to come in the near future. Even if approved, the completion of the pipeline will require at least two years of work. The Keystone XL approval may take years, especially if a new Democrat becomes the tenant of the White House over the next four years.

Energy East Pipeline The Energy East Pipeline (e.g. see fig. 3) is 4,600-kilometer pipeline that will transport 1.1 million barrels of oil sands on a daily basis from the oil rich Western provinces of Canada to refineries in the East coast. The 12 billion-dollar pipeline will drastically lessen Eastern Canada’s dependence on imported crude oil. Crude from the pipeline will also be shipped to energy markets in Asia. The project will benefit the Canadian economy by creating thousands of jobs and billions of dollars in tax revenue. TRP has formally filed the project application for the Energy East Pipeline project with the National Energy Board of Canada last October. TRP hopes to begin in 2017 and operations by 2020.

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(Fig. 3)

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SWOT Analysis Strengths Weaknesses

Large Pipeline Presence in North America

Strong Energy Generation

History of Safe Pipeline Operation

Heavily Dependent on Natural Gas Transportation

Extraction of Oil Sands

Opportunities Threats Approval of Keystone XL

Increasing Energy Demand in Canada

Growing Oil Production in the U.S

Decreasing Coal Reserve

U.S Election (R)

Migration Towards Renewable Energy

U.S and Canadian Regulations

U.S Election (D)

Environmentalist Group

Geopolitics

Oil Price

Competitors

(Fig. 4)

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The above table (e.g. see fig.4) shows a list of TRP’s competitors. TRP’s biggest competitor remains Enbrige Inc. (EBN) and Kinder Morgan Inc. (KMI) because of their geographical positions.

Macroeconomic Situation The recent drop in oil price has negatively impacted TRP’s share prices. The sharp drop in the oil price boils down to one of the most fundamental economics concept: Supply and demand. Excess of Supply: In 2014, prices of crude oil have come under pressure when global output overly exceeded total demand and analysts forecasted that the excess of supply would continue to build in 2015 as we are noticing today. The excess of supply came mainly from the United States, which increased global output by more than 1 million barrels a day in 2014 and is on track for an additional million in 2015. Oil production from countries like Canada and Iraq continue to rise year after year. Last November, the Organization of the Petroleum Exporting Countries, commonly known as OPEC, had the opportunity to curb production and stabilize the oil price. However, they elected not to intervene. Saudi officials, who are very influential in the organization, are worried that a cut in production may result in market share loss. A recent survey by Reuters showed that OPEC oil output has increased in September to 31.57 million barrels per day which reiterates Saudi Arabia and other Arab states’ commitment to defending market share regardless of price effects. The organization has added almost 1.5 million barrels per day since last November strategic move. OPEC officials are hoping that the low price will curb production in the United States and make production less attractive for competitors like Russia. Additionally, the nuclear deal with Iran, which has the fourth-largest oil reserve in the world, will contribute to the increasing oil output. The cheap oil price may continue well into 2016. Weakening Demand Over the past six years the U.S, formerly the largest importer of crude oil last year has nearly doubled its total production, which considerably decrease total imports. Countries like Saudi and Nigeria who heavily sold their oil to the U.S are now forced to sell their production to weaker economies in the Asian markets, resulting in lower prices. The slowdown in the European economy and developing countries and more energy-efficient vehicles has also weakened total demand. Finally, recent devaluation in the Chinese currency may be indicating possible weaknesses in the economy of the world’s largest oil importer. We may even see lower oil prices in 2016. The current OPEC strategy and the lifting sanctions related to the Iranian nuclear program will impediment a sufficient rebound in oil price that will substantially benefit TRP’s stock price in the immediate future. The following graph (e.g. see fig. 5) shows how the drop in oil price has affected TRP’s share price since the fund purchased TRP.

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(Fig.5)

Growth Analysis In 2014, TRP’s total revenue grew 15.77% to $ 10,185 billion year over year. TRP is projected to reach $10,866 billion in total revenue this year. TRP’s diversified portfolio has allowed the company to continue to grow year over year despite the multitude regulatory threats and the recent drop in oil price. While providing a safe revenue stream, TRP’s energy business is poised for growth, as the United States and Canada continue their efforts towards renewable energy. Last year, TRP’s natural gas and liquid pipeline provided over 63% of the company’s total revenue. Depending on regulatory approval and the outcome of the next American election, TRP’s pipeline revenue could grow exponentially with the approval of Keystone XL and the Energy East Pipeline. The growing oil production in both Canada and the United States can largely benefit TRP’s pipeline business. Despite TRP’s continued growth, the recent turmoil in the energy sector caused by the drop in oil price has unfavorably affected the company’s stock price. TRP is currently trading at $33.15, or 24.71% lower than our entry point.

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(Fig.6)

Relative Valuation

EPSx EPS Est. (Next 4Qtrs)

Price EBITDAx EBITDA/Shr. (Nest 4Qtrs.)

Weighted Price

Weighted Price (75%P/E -25% EBITDA)

Bull 15.88 $2.50 39.76 11.59 8.12 94.16 $53.36

Base 15.34 $2.50 38.41 11.20 8.12 90.97 $51.55

Bear 14.80 $2.50 37.07 10.81 8.12 87.79 $49.75

For the 12-month price range, I used a 75/25 weighted EPS and EBITDA multiple valuation. The multiples were adjusted down given the regulatory and risks associated Keystone XL and the Energy East Pipeline project. I decided to put a heavier weight (75%) on the EPS multiple because of the significance of TRP’s interest expense. The usage of an equally weighted method would be too bullish. TRP’s 12-month target price is $49.75 - $53.36

Dividend Revenue The table below shows the dividend revenue stream since the fund purchased TRP’s shares. TRP’s steady revenue growth has allowed the company to increase its dividend yield over the past couple of years. Besides the capital gains, the fund projected dividend yield gains of $ 300 over three years. In less than two years, the fund collected $ 271.72 in

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dividend yield gains, exceeding our expectations. TRP’s current dividend yield is 4.93%. The fund currently holds 72 shares of TRP.

Ticker Date Transaction $/Share $ Total Amount

12/27/2013 Dividend (Paid to Cash)

0.46 33.12


0.48 34.56


0.48 34.56


0.43 30.96


0.48 34.56


0.52 37.44


0.52 37.44

09/28/2015 Dividend (Scheduled) 0.39 29.08

Total 271.72

Investment Thesis TRP’s diversified portfolio and strong presence in North America has made them one of the strongest energy company in the continent. Their ambitious pipeline projects, if approved, can grow the company exponentially in the future. The current $33.15 per share price is relatively cheap and should attract long-term investors. However, the company is heavily dependent on oil prices and regulatory approval. Given the current geopolitical situation, I do not expect a sufficient rebound in the oil price that can propel the stock back to the $45 dollar range (entry point) in the immediate future. Also, I do not expect the approval of the Keystone XL pipeline under President Obama’s administration. As a student fund, we do not trade as often as we would like which is why we still have not sold TRP’s shares to limit our losses. I suggest that we trim down our position from 72 shares to 30 shares. This decision will reduce our exposure to recent volatility in the energy sector, while maintaining enough exposure in case of a rebound in Oil price following the OPEC meeting in December. I suggest that the fund allocates the proceeds from the sale of TRP’s shares to investment in more promising sectors such as Technology, Healthcare, and Financials.

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Resources: Bloomberg Terminal Morningstar New York Times TransCanada 2014 Annual Report

TransCanada (TRP) current holding report - SELL

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