TC Energy Corp T.TRP

CIBC comments

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Initial Take: Liquids Spin-Out a Surprise; More Importantly, Coastal GasLink on Track

OUR TAKE: Mixed. Following a two-year strategic review, TC Energy announced that it would spin out its liquids business in a tax-free manner in H2/24. A spin-out or sale of the liquids business has often been discussed over the last few years with investors, and we see it yielding a higher growth natural gas / power business and a lower growth liquids pipeline business. That said, the spin-out does not alter our consolidated leverage and funding outlook for the company, which is the key focus for the market. On a positive note, the key Coastal GasLink (CGL) and Southeast Gateway (SGP) projects remain on schedule and on budget. The company also reiterated its outlook for dividend growth, and we view the current ~7.9% as sustainable. In terms of quarterly results, while there were some moving parts, EPS and EBITDA were broadly in line with expectations.

At 11.0x 2024E P/E and an 11.7% 2024E free cash flow yield, we do not believe the market is reflecting the long-term value of TC Energy’s asset base. We will revisit our estimates following the conference call tomorrow at 8:30 a.m. ET, dial-in: 1-800-319-4610.

KEY POINTS

Liquids spin out a surprise. Following a two-year strategic review, TC Energy announced that it would spin off its liquids business on a tax-free basis in H2/24. Full slide deck on the transaction can be found here (link).

• Focus on longer-term growth. Management believes that the spin out of the liquids business will better position the two separate companies to pursue growth opportunities longer-term. Post spin-out, management sees a 7% EBITDA CAGR out to 2026 for the base business, while liquids will have 2%-3% EBITDA growth. These overall growth rates would be largely in-line (slightly better) with what was presented at the 2022 Investor Day. Over the next few years, we do not expect the split to alter the growth rates of the two companies given the lead-time for new projects as well as the capital requirements to build the SGP.
• Continued dividend growth. There is no change to the dividend outlook, as following the split, the combined dividend of the two companies is planned to be equivalent to TC Energy’s dividend. TC Energy continues to see dividend growth of 3%-5% with a 2022-2026 average EPS payout ratio of ~90% and AFFO payout ratio of ~50%. The liquids business is expected to grow the dividend by 2%-3%.
• No change to consolidated leverage. The company intends to have ~$8b of senior and subordinated debt at the liquids company when it is spun out to yield a debt to EBITDA of ~5x. The expectation is that both TC Energy and the Liquids business will be investment grade. The transaction does not change our near-term consolidated leverage or funding outlooks.

• Costs and efficiencies. Creating a new company will come with added corporate and public company costs. Management believes they can offset these costs with various efficiency measures. It has identified $750m of annual run-rate cost opportunities that can be realized by the end of 2025, with $150m of these being implemented already. They also see the potential for an additional $250m of initiatives beyond 2023. These efficiencies are driven in part by the integration of the three natural gas businesses (Canada, U.S., Mexico) into a unified business unit. Management believes these cost savings offset any higher costs associated with the spin out.
• Timing and approvals. The transaction requires shareholder approval at a meeting that is expected to be held in mid-2024. It will also require favourable tax rulings, various regulatory approvals, and other closing conditions. Closing is expected H2/24.
• Fair size pure-play crude oil pipeline. A 10x-10.5x multiple on the expected run rate EBITDA of $1.5b implies a $15.0b-$15.8b enterprise value for the new liquids company. Assuming $8b of debt implies a $7.0b-$7.8b market cap.

Additional asset sales expected. Management noted that it continues to evaluate asset sales and is contemplating a further $3b of monetizations. These could happen out to the end of 2024, and it is likely that they would be accomplished through a number of transactions. Our model currently assumes $2.5b of asset sales by year-end.

 

Moderating 2023 EPS guidance as expected. In part due to the previously announced Columbia stake sale (link), TC Energy has moderated its 2023 EPS outlook to in-line with 2022 levels versus modestly higher previously. Our 2023 EPS estimate implies 1% growth, while consensus is below 2022 levels. The company reiterated its 2023 ~5%-7% EBITDA growth guidance. Our 2023 EBITDA estimate of $10,426m implies ~5% y/y growth, which is near the lower end of the range. The company also reiterated its 2023 capital expenditures guidance of $11.5b-$12.0b, which it expects to fund with cash flow, debt, hybrids as well as its asset sale program.

Coastal GasLink — So far so good. Coastal GasLink’s (CGL) construction continues to track in-line with its prior schedule and budget, which we view as a positive. The project is now 91% complete and welding is ~98% complete. Pipeline has been completed and backfilled in 639 km of the 670 km route. This update was largely in-line with messaging from our recent Calgary Stampede roundtable discussion with the company (link).

Soft U.S. Natural Gas Pipelines. U.S. Gas Pipelines was weaker than we expected, generating $925m of EBITDA versus our $1,016m estimate. The miss versus our estimate was mainly at “Other U.S. Pipelines” and to a lesser degree ANR and Columbia. Canadian Natural Gas Pipelines EBITDA of $780m was 7% above our $728m estimate with the segment benefiting from strong Mainline incentive income as well as a solid NGTL System contribution. Finally, the Mexico assets generated EBITDA of $193m versus our $179m, as the Sur de Texas contribution was not as weak as we had anticipated. While still early days, the SGP project is on time and budget.

Liquids stronger than expected. Liquids Pipeline EBITDA of $363m was much stronger than our $329m estimate. However, there was an increase to the estimated Keystone spill cost from $650m to $794m. It expects to recover the majority of this through insurance.

 

Solid Bruce utilization. Power & Storage EBITDA of $217m was behind our $243m estimate largely due to a weaker-than-expected contribution from natural gas storage. Bruce Power EBITDA was above our estimate and benefitted from 94% utilization, while Canadian Power was slightly below our estimate.

Key items we are looking for with Q2. We expect the move to spin-out the Liquids business will be a popular topic on the call, along with questions on progress at Coastal GasLink. We will also look for commentary on the Columbia transaction (link), and further asset sales.