In an environment that is extremely bearish when it comes buying stocks in the oil and gas sector, those seeking out strong Canadian dividend stocks often wonder if there is still opportunities in the sector.
The oil and gas sector is one that is often lauded for its high income potential, especially pre-pandemic. But, that has changed. Junior oil and gas companies along with even some blue-chip majors like Suncor Energy (TSE:SU) have slashed their dividends, and initial capital invested into these companies by Canadians is more than likely gone forever.
The sector has been dying for the better part of 15 years. If you look to the 3 major producers Canadian Natural, Suncor Energy, and Imperial Oil, not one of them has managed to keep its head above water. In fact, all 3 are quickly drowning right now.
Investors who chose any other producers other than Canadian Natural have suffered significant losses.
However, there’s a little nook of the oil and gas sector that’s doing just fine right now, and that is pipelines. One of those pipeline companies is TC Energy (TSE:TRP), and we’re going to go over whether or not the company is a solid play in terms of both growth and dividends. Lets get started.
TC Energy (TSE:TRP) Dividend and stock analysis
Market Cap: $53.37 billion
Forward P/E: 13.99
Dividend Growth Streak: 19 years
Payout Ratio (Earnings): 70.28%
Payout Ratio (Free Cash Flows): Premium Members Only
Payout Ratio (Operating Cash Flows): Premium Members Only
1 Yr Div Growth Rate: 8.70%
5 Yr Div Growth Rate: Premium Members Only
Stocktrades Growth Score: Premium Members Only
Stocktrades Dividend Safety Score: Premium Members Only
TC Energy is a leading Canadian pipeline company with over 93,300 km of natural gas pipeline and 4,200 MW of power generation. In 2019, the company generated 68% of its EBITDA from natural gas pipelines, a commodity that is not going to go anywhere, anytime soon.
A lot of Canadian investors shy away from pipeline companies due to high payout ratios in terms of earnings. It’s important to note that payout ratios in terms of earnings aren’t as relevant for pipeline companies as dividend payout ratios are in terms of distributable and free cash flows.
When we spend a little more time and look at these ratios instead, we can paint a much better picture of the safety of a pipeline company’s dividend. Fortunately, TC Energy’s payout ratios are safe when it comes to both earnings and cash flows.
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As we can see with the chart above, TC Energy yields around 5.65% at the time of writing, and it’s yield hasn’t been this high in the last half decade except for the short-term correction we saw in late 2018, and the COVID crash.
In terms of payout ratio, the company is currently paying out 66.39% of trailing twelve month earnings. If a company passes the earnings test in terms of dividend payout, It’s going to pass in terms of free cash flows.
The company has raised the dividend for 19 straight years, and has raised its dividend by 9.34% on an annual basis over the last half decade. Since the year 2000, the company has a compound annual growth rate on its dividend of around 7%, and TC Energy has been slowly increasing this over the last 5 years, hoping to achieve 8-10% CAGR growth from 2015 to 2020.
Now, this is an impressive growth rate for a company its size. However they’ve realized the current economic environment will more than likely result in slowing growth. That is exactly why it has stated beyond 2021, they expect the dividend to grow in the 5-7% range.
Considering this is a stock that yields over 5.5%, I imagine investors are more than happy with this expected growth. And, considering TC Energy has delivered this type of growth over the last 2 decades, I imagine it will follow through moving forward.
Not only is TC Energy’s dividend safe, it’s one of the best in the country. The key question is how is the company going to continue to grow the dividend. Similar question being asked about Canadian Tire (TSE:CTC.A) right now. In order to do so, TC Energy will need to continue driving earnings higher. Lets take a look.
TC Energy forward outlook and valuation
Lots of investors throw blanket assumptions over both producers and pipelines, and they’re making a huge mistake. There is no doubt producers have been hit hard by the pandemic. But not only has TC Energy not suffered even close to the decline in share price this year, it says its business operations have been untouched by the COVID-19 pandemic.
In order to understand how this is possible, you really need to understand how pipelines work. TC Energy, along with other major pipelines like Enbridge generate a significant portion of their revenue from rate-regulated assets and long term take or pay contracts.
A take or pay contract is an agreement between a producer and the pipeline, wherein the producer pays the pipeline company regardless of the product being shipped. So, if the producer decides not to move any product, they’re still paying the pipeline.
And the cherry on top of all of this? The pipeline can go ahead and sell the space to another producer.
Approximately 95% of TC Energy’s EBITDA comes from these types of contracts and rate regulated assets. This is why we’ve seen little to no impact on its operations.
And, it’s also why the company has the capital to go ahead with $37 billion in capital expansion through 2023.
On a price to earnings basis, TC Energy is one of the cheapest pipelines in the sector, despite its operations being relatively unaffected.
Stocks like Pembina Pipeline and Keyera offer significantly higher dividend yields than TC Energy, and I have a feeling this is what is causing the valuation discrepancies between the two.
A word of caution however. Don’t get tunnel vision when it comes to dividend yield in the oil and gas sector. Look no further than investors of Vermillion Energy (TSE:VET), who have watched an investment in 2017 in the company go from $57 to under $3.50.
TC Energy on a historical basis, at least over the last 5 years, has never been this cheap.
The company is still down 16% year to date despite it’s operations remaining untouched by COVID-19. The company’s near 70% reliance on natural gas to drive revenue should put cautious investors minds at ease. Although there is no doubt as a population we’re trying to and will eventually phase out oil, natural gas will remain vital to human life for a much longer period of time.
Overall, TC Energy is the best pipeline option
If you’re looking for a solid income option in the oil and gas sector, I feel there is no better than TC Energy. The company has the safest dividend out of all the major pipelines, and is trading at a discount relative to other major pipelines as well.
The company has proven time and time again over the last 20 years that it can grow its dividend, and has stated, despite COVID-19, it will continue to do so. I’d be a little more leery on anticipated dividend growth with a company in the sector that didn’t have as much history, but I’m not worried with TC Energy at all.