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Major gas pipeline project is no panacea for TransCanada balance sheet

TransCanada Corp.'s decision to greenlight a C$6.2 billion natural gas pipeline should guarantee a steady revenue stream for the company, but investors and analysts do not see it as a silver bullet for the Canadian pipeline giant's balance sheet issues.

TransCanada will construct the 2.1-Bcf/d Coastal GasLink pipeline to supply gas to a large, Royal Dutch Shell PLC-led export project in British Columbia. The partners on the LNG Canada project reached a positive final investment decision Oct. 2.

With LNG Canada poised to collect offtake commitments in addition to the project partners' supply shares, Coastal GasLink is expected to benefit from what analysts at energy investment bank Tudor Pickering Holt & Co. called "robust long-term re-contracting," as well as support from First Nations whose land it would cross.

Optimism about the pipeline project, however, did not necessarily translate into a more positive equity outlook for TransCanada. Its unit price has declined 17.0% in 2018. Shares got a brief boost after the company's Oct. 2 decision to go ahead with Coastal GasLink, but after that they dipped 2.5% compared to the day before that announcement.

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The hesitancy to reward TransCanada on the stock market is due in large part to its equity funding overhang, according to Veritas Investment Research Corp. Vice President Darryl McCoubrey, who oversees the firm's utilities and infrastructure coverage.

"It creates a higher hurdle for them to cross to deliver some of the dividend growth guidance that they've broadcast," he said in an interview. "The sentiment that we're hearing from investors is that it's okay for the dividend growth to be modestly lower than what you're saying if you can get the balance sheet in order … because cost of capital is everything."

Several energy pipeline companies, particularly those structured as master limited partnerships, have pivoted toward retaining more cash on hand to avoid tapping high-cost public equity, opting to slow down distribution and dividend growth to balance their books. TransCanada, on the other hand, needs a quick fix for its C$2 billion of near-term equity requirements, given a C$30 billion growth backlog through 2022, Tudor Pickering Holt analysts wrote in an Oct. 10 note to clients. They said the problem seems to be compounded by a lackluster market for the equity the company is offering.

"The stock's performance continues to lag behind the midstream sector [year-to-date] with short interest topping the peer group in recent months largely driven by fear of steady [at-the-market] issuances outpacing buyer interest," the analysts wrote.

TC PipeLines LP's troubles have also weighed on TransCanada in recent months. The MLP in May announced a 35% distribution cut after the Federal Energy Regulatory Commission's March 15 decision that pipelines organized as oil and gas master limited partnerships were no longer eligible for a key tax benefit. Afterward, TransCanada stated that it no longer saw TC PipeLines as a viable vehicle for dropping down U.S. assets due to the projected financial impact of the FERC policy change.

Since March 14, the MLP's shares have plummeted 38.4%, failing to fully recover even after FERC softened its stance in a July 18 final ruling. The bellwether Alerian MLP Index, on the other hand, has gained 5.9% on a price-return basis since March 14.

But rather than selling TC PipeLines to replenish its coffers, TransCanada will more likely seek out joint venture partners for existing projects, including the Coastal GasLink pipeline, McCoubrey said. "We believe TransCanada must divest at least 20% for the project," he said.