Piping connecting to TC Energy's Coastal GasLink natural gas pipeline terminus at the LNG Canada export terminal under construction, in Kitimat, B.C., on Sept. 2022.DARRYL DYCK/The Canadian Press
Staring down an unsustainable debt load, with few foreseeable catalysts to alleviate the burden, TC Energy Corp. TRP-T hopes to reinvent itself by spinning out the oil division that defined its growth ambitions last decade.
But 24 hours into what management calls a “monumental moment” for the company, TC’s share-price slump has only accelerated, and analysts are questioning the very purpose of the reorganization, because it does little to lower the company’s debt burden in the near future.
TC, formerly called TransCanada Corp., believes hiving off its oil pipelines – known as “liquids” pipelines in the industry – into a separate publicly traded company will allow management “to pursue more growth for the benefit of our shareholders than we could today,” chief executive François Poirier said on a conference call Friday.
Yet a team of analysts at Toronto-Dominion Bank TD-T wrote in a client research note that they are “skeptical that any liquids spinoff would unlock value for shareholders.”
“Indeed,” the analysts said, “we see execution risk introducing uncertainty and potentially distracting TC from its existing strategic priorities.”
At the top of that priority list is repaying debt. Once again, TC is struggling with the weight of its balance sheet.
The last time this happened, in 1999, the company had racked up debt from a string of acquisitions, including the takeover of Alberta-based Nova Corp., and investors started to flee. To fix things, management announced $3-billion in asset sales, but also chopped TC’s dividend to save cash – and that only angered shareholders even more.
This time around, TC is hampered by debt accumulated through its industry-leading capital investment plan that projects spending $30-billion between 2023 and 2026. The company has also struggled with massive cost overruns at its Coastal GasLink pipeline.
Rather than slash the dividend to redirect cash toward debt repayment, TC is proposing to split itself up – even though it is unclear if doing so will do much for the debt burden in the near future.
TC’s shares fell another 4.3 per cent Friday, ending the week down 13.4 per cent to close at their lowest level since 2015.
The proposed split echoes one-time energy giant Encana Corp.’s decision to split in two by spinning out its oil sands division to create Cenovus Energy Inc.
More recently, Teck Resources Ltd. TECK-B-T attempted to spin out its metallurgical coal division into a separately traded company earlier this year. Teck tried to hive off its steelmaking coal business, which has a high carbon intensity, and keep copper production that is seen as necessary for the energy transition.
So far, Teck has not been successful. Heading into the shareholder vote this spring, enough investors had voted against the proposal that Teck was forced to scrap the idea and go back to the drawing board.
While Teck’s proposal was hampered by a structural flaw that would see the coal company pay most of its cash flow back to Teck to fund copper production, the plan had a common framework with TC’s: to appease shareholders concerned about environmental, social and governance principles.
At TC, the oil sands crude that travels through its Keystone pipeline has a higher carbon intensity than that of its natural gas and nuclear power businesses.
TC’s oil pipelines currently contribute around 12 per cent of its total earnings before interest, taxes, depreciation and amortization (EBITDA).
Before the spinout was proposed, TC had stressed that it was focused on asset sales to repay debt. To this end, the company announced on Monday that it would sell 40 per cent of its Columbia gas transmission business in the United States to New York-based Global Infrastructure Partners (GIP) for $5.2-billion.
However, the large cheque wasn’t enough to prevent two credit rating agencies – Moody’s Investors Service and DBRS Morningstar – from downgrading TC’s debt by one notch each. In its report, Moody’s said the major asset sale “will not in itself be sufficient to offset pressure on the balance sheet.”
In the aftermath, analyst and investors have been wondering what else would be sold, and what price, so that debt could shrink some more. Even after the sale, Moody’s expects TC’s leverage to amount to more than 5.5 times its EBITDA “for the next few years.”
Instead, TC’s next move was to unveil a surprise spinout.
“Previously, we believed valuation would rise on asset sales/debt reduction and as Coastal GasLink concerns ease,” BMO Nesbitt Burns analyst Ben Pham wrote in a note to clients Friday. “Now we believe share performance will be driven by perceived value of the two separate entities, and while Nat Gas/Power could trade at a healthy valuation, we are doubtful Liquids will. As such, we are not yet convinced the separation will add value. Instead, we believe it will detract for now.”
On the conference call Friday morning, TC’s management said the company’s current structure had prevented it from exploring growth opportunities for its oil division, because the broader company was hamstrung by its debt, but they did not elaborate on what the opportunities were. As a standalone company, the oil division will be able to grow.
The trade-off, however, is that the oil division is projected to offer lower dividend growth. The natural gas and power generation company is estimating dividend growth of 3 per cent to 5 per cent a year, while the oil pipelines company will deliver 2-per-cent to 3-per-cent annual dividend growth.
Despite spinning out the oil division, which is estimated to generate $1.3-billion in EBITDA this year, TC CEO Mr. Poirier said the company will not have to limit its capital spending because an April commitment to spend up to $6-billion a year was made with the knowledge that TC may end up splitting in two.
TC’s decision to sell the 40-per-cent stake in its U.S.-based Columbia assets and split the company is the culmination a two-year strategic review. The company said Friday that the spinoff has been in the works for six months, with a dedicated department and a chief transition officer working on the plan.
DBRS Morningstar on Friday said it didn’t expect the spinoff to affect TC’s debt ratings, but added that the split would have a modestly negative impact on the company’s business risk profile because of the loss of diversification.
TC declined to comment for this story.