TC Energy Corporation

Moat: 4/5

Understandability: 3/5

Balance Sheet Health: 3/5

TC Energy is a major North American energy infrastructure company, primarily engaged in natural gas and liquids pipelines, and power generation.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

The business is primarily in the energy infrastructure sector, focused on natural gas and liquids pipelines. They also have some investments in power generation.

Business Overview

TC Energy operates in three primary segments:

  1. Canadian Natural Gas Pipelines: This segment transports natural gas through an extensive network in Canada, serving key markets.
  2. U.S. Natural Gas Pipelines: They operate a vast natural gas pipeline system in the United States, connecting major supply basins to demand centers.
  3. Liquids Pipelines: The company owns and operates pipelines that transport crude oil and other liquids primarily within Canada. They also have some pipeline projects in the US.

These core businesses form the foundation for their economic performance.

  1. Other: this segment includes power generation and some other assets, but they are generally a small part of their business.

They recently sold the remaining interest in a power generating plant, so this area may be smaller going ahead.

Industry and Competitive Landscape

The energy infrastructure industry is characterized by high barriers to entry, including large capital outlays, regulatory hurdles, and the need for expertise. TC Energy benefits from:

  • Significant Infrastructure: They have a massive network of pipelines, which are very hard to replicate due to their cost and scale.
  • Long-Term Contracts: The majority of TC Energy’s revenues are derived from long-term, take-or-pay contracts, ensuring relatively stable revenue streams.
  • Regulated Rates: Their regulated pipelines generally operate under tariffs set or approved by regulators, providing a level of revenue predictability.

These three factors make it hard for new players to enter the sector and take market share from incumbents like TC Energy.

Their main competition comes from other large, established energy infrastructure companies. The key factors in competition are service reliability, price competitiveness, and the ability to expand infrastructure to meet future demands. Competitors such as Enbridge, Kinder Morgan, and Williams Companies, are well-known players that compete with TC Energy on different routes and projects.

The industry trends include:

  • Shift to cleaner energy: As the world transitions to cleaner sources of energy, natural gas is seen as a bridge-fuel, which may increase demand for transportation infrastructure in the long term.
  • Shift to electrification and hydrogen: Electric power generation is becoming increasingly popular, reducing the long-term importance of gas as a power source. Moreover, transportation may be switched to hydrogen in the long run. All of this can pose risks to the long-term demand of natural gas, and could make companies that only have exposure to gas less valuable.
  • Increased scrutiny: ESG investing has increased the scrutiny on energy companies, which are seen as bad from an environmental point of view.

The increased scrutiny may pose some downside risk to the company and its growth prospects.

Moat Analysis

TC Energy is likely to have a wide moat. Here’s why:

  1. Scale-Based Moat: They have a massive network of pipelines across North America and an incredible ability to move natural gas and oil, which is impossible to replicate without massive investments and scale. For a competitor to compete with them head to head, they would need a huge amount of capital and expertise to lay pipelines similar to them.

This acts as a huge barrier to entry.

  1. Switching Costs: The cost of switching providers for pipeline transport is extremely high because it involves huge investments and new regulatory hurdles that companies are generally not going to engage in, leading to sticky long-term contracts with customers. Customers are usually locked into the pipelines for long periods of time and the company has a good predictability of income due to this.

This keeps their customers locked in.

  1. Regulation: They are largely regulated entities, meaning their competition is often restricted by regulators, leading to very few new companies entering the sector.
  2. Niche Markets: The company is focused on certain segments like pipelines which have natural, inbuilt advantages that prevent newcomers from coming in.

Given that they have these factors, we rate their moat at 4 out of 5.

Risks to the Moat and Business Resilience

  • Regulatory Risks: Changes in regulations concerning pipeline operations, tariffs, or environmental approvals can have significant impacts on the profitability and expansion potential of the company. The company is currently dealing with new regulatory requirements in Canada that will make operations and construction more challenging and increase costs to the company.
  • Political Risks: The business is sensitive to government policy and political actions. The political environment can change rapidly and unexpectedly. Companies can be affected in a negative way if governments decide not to renew or change regulations or approvals. For example, political uncertainties in the United States regarding pipeline approvals could limit growth opportunities.
  • Market volatility: The company’s revenues are strongly correlated to natural gas prices. Volatility of natural gas prices, along with the market sentiment and prices, can influence the company’s earnings in the short term and valuation. For example, during the energy crash of 2020 the company’s share price plummeted, but then has recovered as prices recovered.
  • Project Risks: The failure to complete or manage projects on time, on budget and within operational parameters could lead to huge losses and might impact future returns. It was mentioned in their last earnings call that coastal gaslink will not be done in 2023, will require more cash from the company, and will be delayed further due to cost overruns, a setback to the company.
  • Technological Disruption: Even though they operate in seemingly non-technological area, changes in energy mix in long term can create havoc. Increased renewable production may mean that the demand for gas and oil will decline. The advent of new sources of energy for transportation and heating, can also create a threat.
  • Leverage: The company currently has debt that might make them more susceptible to bankruptcy if their business deteriorates.

They have a lot of debt which, while benefiting their returns, also increases risk.

  • Environmental Concerns: Negative perception of pipelines as contributors to greenhouse gas emissions can put some pressure on the company and investors. The company has tried to incorporate these concerns and are working on methods to reduce their environmental impact. But this issue is still expected to be on investor’s minds.

The management is actively looking into lowering their carbon footprint.

Despite these risks, TC Energy’s diversified operations across North America, strong customer relationships, and generally positive economic fundamentals provide good resilience, giving them the ability to withstand major changes.

Financial Analysis

  • Revenue Distribution: The majority of TC Energy’s revenue is from its natural gas transmission operations, which are approximately equally split between their US and Canada systems. They also generate significant revenues from their liquids pipelines, though that is not as big of a portion. Power generation and other revenues are just a small part of total revenue.

It is a large gas transmission business in both US and Canada.

  • Margins: Over the long term, operating margins have fluctuated in the 40 to 60 percent range. Profitability has decreased recently due to higher costs and interest payments.

Although profitability has decreased, it might recover with future increase in the tariffs.

  • Capital Expenditures: TC Energy requires very high capital expenditures because of its infrastructure requirements. Capital expenditure can sometimes put pressure on profits. Also, most of this spending is for maintenance rather than growth, with a growing percentage of their assets becoming older.

These high spending amounts could put a strain on the long-term financial sustainability of the company.

  • Debt: TC Energy has a high level of debt which may seem alarming. Much of the debt is tied to the company’s assets, which provide some level of security.

The high level of debt means the company is more vulnerable to negative changes in the business.

  • Earnings: Their net income is currently low as they have many write-offs, including for the coastal gas link pipeline. Their normalized earnings will be better as soon as construction is over.

Current profits do not truly reflect the profitability of the business and will be better going forward.

Understandability

While the business model is relatively straightforward, the complexity arises when analyzing the intricacies of long-term contracts, regulations, and capital expenditure plans.

Therefore, a rating of 3 out of 5 is applied. It is not difficult to get the basic concepts but digging deeper to understand all the ins and outs might prove tricky for a new investor.

Balance Sheet Health

  • Leverage: As mentioned above, the company is carrying a high amount of debt. Because of this, its debt-to-equity ratio may not be ideal for a conservative investor.
  • Liquidity: The company’s operations generate a good amount of free cash flow, but they need to reinvest a good chunk of that to improve their pipelines and assets, and to maintain their dividends.

The company’s capital spend can impact its short term financial situation, so it may not be that great for quick or volatile returns. Given the above mentioned points, and the company’s high leverage, it will be correct to provide it a rating of 3 out of 5 for the balance sheet.

Recent Concerns

  • Coastal Gaslink Project: As mentioned earlier, TC Energy is experiencing significant cost overruns and delays on this pipeline, increasing concerns about the management of large projects. This has caused the company to decrease its future earnings predictions and increase the budget needed to finish the project.
  • Tariff issues: The company is dealing with negative results regarding some tariff filings in their Canadian pipelines, as a result they’re underperforming from an earnings point of view. It seems their future earnings are tied to resolving this matter.
  • Reorganization: Due to these issues and a strategic shift in business focus, the company is under a reorganization program, which might add uncertainty.

Despite these issues, the management seems confident that things are being handled correctly and that performance will improve soon.

Summary

TC Energy is a critical component of the North American energy infrastructure. Their wide moat and long-term contractual agreements provide a solid foundation for future earnings. Although some issues, like the coastal gas link delays and debt load, impact the stability and short term outlook, their long-term business prospects look good. As an investor, it is key to keep an eye on changes in regulation, emerging markets, and technological disruptions. However, overall, it presents a strong business that an investor can depend on, making this a good stock for a long-term value investor.