We’ve got a jam-packed newsletter this weekend. First off, we’re going to speak on the big TC Energy news involving the spinoff. Secondly, we’re going to speak on some Foundational Stocks that reported earnings.
There were a lot of companies highlighted here that reported earnings, but we’re going to delay most of them to next week and further weeks ahead due to the fact a lot of members want some insight on the TC Energy spinoff.
With that said, lets get started.
TC Energy splitting into two
The TC Energy split news was a big one, and it came amidst a busy earnings season. Now that we’ve had time to digest the information, this week’s key focus will be TC, as we realize it is a very popular stock here in Canada and among members.
Let’s start with the basics. TC Energy announced that it would split into two publicly traded companies via a tax-free spinoff of its oil pipeline business. What is left will be as follows:
- TC Energy: Natural gas pipelines, storage and power businesses
- Liquids Pipelines Company: Name TBD and will be a liquids pipelines and storage business
TC Energy will be a higher-growth business focusing primarily on natural gas, nuclear and hydrogen. At the same time, the liquids pipeline company will be a lower-growth company and will be focused on increasing capacity on underutilized points in the system.
The company expects the spinoff to close in the second half of 2024.
The benefits of the spinoff
Now, let’s get into the benefits of the spinoff, and if we are honest – we don’t see too many. As per TC Energy, the spinoff will unlock value, provide efficiencies, better strategic focus, enhanced flexibility, etc. Honestly, pretty much all standard stuff and nothing that stands out.
There has been plenty of attention on the company’s debt load, and many are taking this spinoff as an opportunity for them to be better positioned financially. Even the company spent a lot of time in their presentation talking about “Enhancing Balance Sheet Strength and Flexibility” and “Advance Deleveraging Targets.”
While this is all and good, the significant deleveraging is mainly taking place thanks to the $5.2B monetization of 40% of its Columbia assets and future planned sales totaling ~$3B. First off, the $5.2B was lower than the markets expected, and secondly, how is this a benefit of the spinoff? In reality, it’s not as it would occur regardless. In our opinion, that is a little misleading.
Secondly, when we talk about efficiencies, strategic focus, etc., – typically, there is hard data to accompany these statements. So what hard data is available to us? Outside of the information above on leverage, only two data points – adjusted EBITDA and dividend growth.
The impact to earnings & the dividend
According to the company’s presentation, TC Energy and the Liquids Pipeline company will have targeted annual dividend growth rates of 3-5% and 2-3%, respectively. Previously, the pre-spinoff entity had guided towards 3-5% dividend growth. Since we expect the Liquids Pipeline to be the higher-yield company, this likely means lower overall dividend growth as separate companies versus as a whole. It’s a minor change, but worth noting.
Shifting our focus to Adjusted EBITDA, pre-spinoff TC Energy is expected to deliver a 6% compound annual growth rate through 2026 and exit that year with $12.5B in combined adjusted EBITDA ($11.1B from TC Energy and $1.4B from Liquids Pipeline). Separately, growth is now expected to be in the 6-7% range and reach $12.7B ($11.2B from TC Energy and $1.5B from Liquids Pipeline).
These are minor changes over two years, and one could also argue that they could have achieved this level of growth without the spinoff.
Finally, let’s talk about ‘unlocking value’
This is typically a buzzword when companies do spinoffs. Usually, this means that the company feels that a certain segment of its business is not being valued appropriately by the market. By spinning it off, they can ‘unlock’ that value.
We believe this will be true of post-spinoff TC Energy in the sense that this will be a higher growth company. It is likely to command a higher premium than what the current TC Energy commands today (which is trading at valuations not seen since 2005).
On the flip side, the Liquids Pipeline company will likely end up trading at a bigger discount. At this point, it is unclear where growth will come from, and it could simply be a declining business.
Our overall thoughts on the spinoff
Either way, we could be looking at a situation where these two pieces offset each other, leaving current shareholders no better off. All in all, we view the split as a net neutral.
They effectively added another level of complexity to the business so they could better focus on the individual businesses. While this ‘strategic focus’ could be beneficial, once again, one could argue that a simple internal restructure could have achieved that.
Post-spinoff, we view TC Energy as the more attractive business. We assume that the Liquids Pipeline business will generate more yield but offers little else in attractiveness – at least based on the information at hand.
If we completely ignore the spinoff and instead focus on the business, TC Energy is certainly cheap. The company is trading at a near 25% discount to its historical averages and at only 11.75x expected earnings.
The dividend looks to be well covered, and it should continue to provide solid income to investors, while providing some upside potential in share price as well. The spinoff just seems a tad confusing to us at this point, with no clear cut benefit for shareholders.
Thoughts on the insider buying happening right now
Before we close off our thoughts, we wanted to talk about the massive insider buying currently happening. Since the announcement, about a dozen different insiders bought close to $6M in shares on the open market. These are true insider buys, not attached to performance options or anything like that.
There are two ways to look at this. On the one hand, it can be viewed as management being bullish on the spinoff. On the other, one could question if this is a ploy to restore confidence in the company and boost the share price. In our opinion, we don’t read too much into this. There hasn’t been a ton of insider buying before this, and most have come post-issue of executive share units that were exercised for cash.
The level of insider buying is undoubtedly impressive, but the timing of it also leaves some questions. That said, since we can’t put ourselves in the mindset of the insiders, we don’t factor it into our decision-making.
Whether it is bullish or not, we want our members to be mindful that relying on insider trading for bullish signals can be risky. We don’t know the motivations behind these buys, especially after such a big announcement.
Foundational Stock Earnings
Waste Connections (TSE:WCN)
Waste Connections put up another steady quarter, as revenue of $2.02B came inline with estimates and earnings per share of $1.02 beat expectations by a penny. The company continues to put up strong, double-digit growth across virtually all segments.
Its solid waste collection, which makes up nearly three quarters of the company’s total revenue, grew by 14.4% and its solid waste disposal, which makes up around 20% of the company’s revenue, grew by 12.1%. The company has also spent $253.3M on acquisitions through the first 6 months of the year that are expected to drive over $160M in annual revenue generation for the company. One of these acquisitions is Arrowhead Environmental Holdings, which is the largest integrated waste-to-trail disposal networks in the Northeast United States.
The company did end up upgrading and downgrading its Fiscal 2023 guidance in a variety of areas, which goes as follows:
- Revenue is estimated to be approximately $8.025 billion, down $25 million from its original outlook to reflect a reduction in fuel and material surcharges of $35 million as a result of lower fuel costs.
- Adjusted EBITDA is estimated to be approximately $2.525 billion, or about 31.5% of revenue, as compared to its original outlook for adjusted EBITDA of $2.500 billion or 31.1% of revenue.
- Capital expenditures are estimated to be approximately $950 million, up $25 million from its original outlook.
As you can see, the company maintains pretty tight guidance, adjusted whenever they feel there is even a slight deviation from expected numbers. Overall, this leads to less surprises and less volatility.
It was another strong quarter from the company, one that simply keeps doing its thing despite the economic uncertainty.
Telus (TSE:T)
Considering the company’s drawdown as of late, there was a lot of eyes on Telus’s earnings.
Telus reported mixed second quarter 2023 results. Although revenue of $4.96B was relatively inline with estimates, earnings per share of $0.19 missed expectations of $0.22. Overall, it was a relatively strong quarter considering the negative sentiment and economic circumstances surrounding the company.
When we look to customer additions, the company reported its second straight record quarter, adding 293,000 new customers. The bulk of these customers came from its mobile and connected device segments, but it still did manage to add over 35,000 new internet customers.
The company posted year over year revenue growth of 13%, free cash flow growth of 36%,and its TTech segment grew operating revenue by 14%. On the flip side, the company saw net income decrease 61%, as higher interest rates and larger amounts of depreciation and amortization and wearing down the income statement.
The company issued its Fiscal 2023 guidance in which it expects:
- Revenue growth of 9.5%-11.5%
- Adjusted EBITDA growth of 7%-8%
- Free cash flow of $1.5B, which is a downgrade from the initial $2.1B guidance issued prior to the Telus International situation
The free cash flow guidance is slightly concerning, as the company does need around $2B in order to pay the dividend. However, the fact that the company has not reduced its Capital Expenditure Plan, maintaining guidance for $2.6B, means it thinks it can generate larger returns in the future from investments in new business and infrastructure this year.
Remember, free cash flows are simply the company’s cash from operations minus its capital expenditures. It could easily reduce CAPEX to generate more free cash flow, but is choosing not to.
With a more inexperienced management team, this would draw concerns from us. However, Telus has done this in the past with large success, so we’re confident in the company’s ability to navigate this current environment and provide strong returns for shareholders in the future.
That said, we don’t expect sentiment to return until the interest rate environment improves.
