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TransCanada Corp. (TRP): Low risk, high dividend yield

Horacio Marquez
0 Comments|June 9, 2010

An additional 50% return possible in the medium term

The U.S. stock market has been choppy these past few weeks and it's no secret why.

The European debt crisis is taking center stage and eliciting strong policy responses from key European governments. And while those policy responses have moved in the right direction, we're still waiting on sustainable progress.

In addition, we are dealing with the uncertainties related to the oil spill in the Gulf of Mexico, which could have very important economic and financial implications.  As if this were not enough, we saw an escalation of the rhetoric in the seemingly endless animosities between North and South Korea, and Hamas and Israel.  And Iran continues to pursue a nuclear arsenal.

On top of it all, Group 20 (G-20) countries are attempting to coordinate economic and financial policies to ensure imbalances are brought back in line, but without incurring huge costs.  So, while Australia, Canada, China, India and Brazil, for example, are preventing domestic inflation from escalating in different ways, the advanced economies are concerned about exactly the opposite: They need to keep looking for ways to foster economic growth and employment.

But in spite of all this uncertainty, I remain bullish.

The strong needs for growth in advanced economies will demand slow exit strategies from their stimulus measures.  Furthermore I believe emerging economies, which are growing at a scorching pace, will be able to control inflation while sacrificing very small amounts of growth.

So, in balance, I continue to see global growth accelerating further.

As for the recent stock market decline, I believe it is just a technical correction that was wholly warranted following the bull market that began in March 2009.  The uncertainties that we are seeing are short term and should be taking backstage to the global growth story in the months ahead.

That is why I generally have been very aggressive with my stock picks this year. 

Still, even though I am dying to recommend a commodity or other cyclical play right now, I am going to restrain myself and recommend a defensive play that should bring strong gains over the medium term with very low risk:  TransCanada Corporation (NYSE: TRP, Stock Forum).

This suggestion will help balance the portfolios of the more bullish investors, like myself, as well as those who wish to put cash to work while limiting their risk.

So, why TransCanada?

I looked hard for a company with sustained, even boring profitability, a rock-solid business model that is positioned in a high barrier-to-entry niche, generous and safe dividends, disciplined management, superior comparables to its industry, market leadership and strong upside potential. And I wanted all of those attributes to be in a strong and stable macroeconomic and legal business environment.

That is a very long and very demanding list of attributes, but they all lead me to TransCanada.

TransCanada is the largest pipeline and utility company in Canada, and as such, it is a critically important strategic company for the country and has superior access to capital, even in the worst of times. These attributes alone make it a desirable core position in any portfolio.

So let's start with the recurrently "boring," but ascending, profits.  The only thing boring about TransCanada's profits is the fact that - by virtue of the company's very low risk and highly regulated businesses - they remain strong even in the worst economic environments. In fact, TransCanada was steadily profitable even through the worst of the economic brick wall and market meltdown that clobbered global markets in late 2008.

TransCanada's market leadership, solid balance sheet and superior positioning and execution, has afforded the company with a 47% gross profit margin that is considerably larger than industry comparables.  This results in much higher profitability ratios than the industry with respect to equity, while carrying lower risk.

The first quarter underperformance in corporate charges should disappear and actually turn around in the second quarter.  The main reason for this swing is that corporate charges in the first three months of the year were below expectations due to an economy that was not up to potential.  But a lot has changed up north, as evidenced by Canada's recent rate increase. 

The Canadian economy is zooming along, with solid banks on the back of strong commodity prices and well-run fiscal accounts. And a solid economy means higher energy demands.  That means higher demand for natural gas, as well as higher prices in the deregulated electricity markets in which TransCanada participates.

Rising energy needs also bode well for the many pipeline projects that would link the north of Canada and Alaska with U.S. consumers.  And TransCanada could very well participate in the construction or operation of liquified natural gas import terminals in the northeastern United States.  All of this should add to a very generous and stable cash flow

The company's large cash flow allows for an equally large, stable and safe dividend yield of 4.6%, which will be dutifully paid on July 29.  So let's line up to collect it by buying the stock now. 

TransCanada is poised to acquire the lion's share of energy market growth and increasing pipeline demands up north.  The stock's valuation is considerably low for such dependable cash flow and strong growth prospects. I'd expect shares to shoot well into the mid-$40 range from its current price of $33.32 for an additional 50% return in the medium term.

Disclosure: Horacio Marquez holds no interest in TransCanada Corporation.

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