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“A pipeline play with pizzazz” — it can only be Canadian

Income investors who follow this U.S. advisory have just gotten a buy recommendation on one of Canada’s two pipeline giants.

The last time we visited the pages of The Complete Investor, this American advisory was recommending that investors sell two Canadian stocks due to doubts about the future of the oil sands. We duly reported it.

In the latest issue, we find the opposite: an enthusiastic recommendation for a Canadian company. Since our preference is to report what appears to be good news for Canadian shareholders, here’s the story.

The company is TransCanada Corp. (TSX, NYSE-TRP). The advisory’s Income Investing section introduces it with the headline “A Pipeline Play with Pizzazz.” And you thought utilities were dull!

Explaining why TransCanada is being added to the advisory’s Income Portfolio, Ms. Genia Turanova calls the company “a different kind of play on pipelines.”

Growth and growing income, too

Ms. Turanova outlines TransCanada’s assets: 36,500 miles of wholly owned pipelines delivering the bulk of Western Canada’s natural gas to markets in Canada and the U.S. Then there are its storage facilities, among the largest in North America, and its power production, which amounts to some 7,700 megawatts in all.

Then she cuts to the heart of the matter — what’s “different” about this pipeline. “TransCanada is one of those rare companies that should provide both growth and growing income for years to come.”

She cites the recent acquisition of ANR Pipeline and Storage as just one step in TransCanada’s plan to improve its strategic position. “Over the next three years,” she adds, “the company plans to invest an additional $4 billion in a portfolio of attractive projects in the above industries as well as in crude oil pipelines and liquefied natural gas.”

TransCanada has filed preliminary paperwork for issuing new shares, but “its cash flow-generating capabilities would suffice to finance a big portion of these investments.” Ms. Turanova adds that funds from operations rose 22 per cent to $2.4 billion, more than enough for new investment and another dividend increase. Its earnings growth of 10 per cent was the highest in the industry.

She concludes: “TransCanada is strongly positioned to benefit from both the energy shortages and the lack of critical infrastructure connecting growing demand for new supply sources in North America. Yielding 3.5 per cent, it is a long-term buy with a target of 45.”

At the close of trading this week, TransCanada stood at $36.59 on the New York Stock Exchange, a scenario that leaves plenty of room for investors to bid up the shares.

Not the only play in the pipeline

While TransCanada is the newest play among pipelines in The Complete Investor’s Income Portfolio, it joins four others with a rather interesting history.

Each of these pipelines is a limited partnership, which bears a strong resemblance to a Canadian income trust. Limited partnerships (LPs) pay no corporate level tax, but pass the majority of their income to investors in the form of regular distributions.

They are the survivors of an American income trust boom that expired 20 years ago. In 1987, Congress legislated against income trusts in the U.S. after a flood of trust conversions threatened a severe loss in tax revenues (sound familiar?). Hence the popularity of Canadian trusts south of the border.

Limited partnerships are restricted to a few businesses, chiefly natural resource extraction and real estate. The vast majority are pipelines.

Another Canadian connection

Canadians wishing to invest in limited partnerships would be subject to the 15 per cent withholding tax dictated by the Canada-U.S. tax treaty. With that restriction in mind, Ms. Turanova’s LPs nonetheless hold a certain interest.

Texas-based TEPPCO (NYSE-TPP) built its first pipeline in World War II to provide safe oil transportation in the face of U-boat attacks on oil tankers off America’s east coast. Penn Virginia (NYSE-PVR) has it own niche as a coal specialist, with growing natural gas operations. NuStar Energy LP (NYSE-NS), formerly known as Valero LP, has one of the world’s largest pipeline networks. Under either name, it has a strong following among U.S. income investors.

Most interesting from a Canadian point of view is Kinder Morgan Energy Partners (NYSE-KMP). Those who follow utilities will recall that in 2005 Kinder Morgan purchased British Columbia’s Terasen Inc. and its large network of oil and natural gas pipelines. Just last week, Kinder Morgan completed the sale of Terasen’s natural gas distribution network back into Canadian hands. The buyer was Fortis Inc. (TSX-FTS) which, from its beginnings as Newfoundland Power, has marched across the country building one of Canada’s largest utilities.

Kinder Morgan’s Canadian connection does not appear in Ms. Turanova’s article, of course. It’s scarcely a major issue for American investors. But let’s not be greedy.

On this first holiday weekend of the summer season, many an income investor will gladly accept the gift of a sparkling recommendation for one of our major pipelines. Especially when it comes with an extra helping of pizzazz.