Seven years ago, TransCanada Corp., as the pipeline giant was then named, was the envy of Canada’s oil and gas sector. As energy producers struggled with the double whammy of plummeting oil prices and the explosion of shale gas reserves in the United States, TransCanada kept trucking along, churning out dividends.
And then, in March, 2016, the company splurged on a US$10.3-billion acquisition of Houston-based Columbia Pipeline Group Inc., offering investors exposure to a prolific shale gas formation in the U.S. Northeast. The deal was so transformative, boosting U.S. profits to roughly half of the company total, that TransCanada ultimately changed its name to TC Energy Corp TRP-T.
It all feels like a lifetime ago. On Monday, TC Energy announced it is selling 40 per cent of Columbia to a private equity firm, and the US$3.9-billion sale price amounts to a far lower multiple to earnings than what TC originally paid.
The hope, it seems, was that investors would be impressed by the company’s ability to generate so much cash in a single deal – and that money would be used to pay down debt. But the opposite has transpired. TC Energy’s share price is down 7.1 per cent since last Friday’s close, before the deal was announced.
Credit rating agencies aren’t all that impressed, either. S&P Global is keeping TC Energy’s debt rating unchanged, but Moody’s Investors Service and DBRS Morningstar both downgraded the company one notch after the deal was announced. In its report Moody’s said the major asset sale “will not in itself be sufficient to offset pressure on the balance sheet.”
Most of this pressure comes from TC Energy’s expansion plans. The company has a sector-leading capital investment program that will see it spend $30-billion between 2023 and 2026, according to Moody’s, and is already wrestling with major cost overruns at its Coastal GasLink pipeline, which will transport Canadian natural gas to a liquefaction facility and export terminal in Kitimat, B.C. Originally projected to cost $6.2-billion to build, the price tag for the pipeline has since soared to $14.5-billion.
Because a good chunk of the expansion plans have been funded by debt, TC Energy has now swapped places with oil and gas producers. In 2016, most Canadian energy companies were struggling with heavy debt burdens and plunging commodity prices; today, producers are watching their share prices soar while transporter TC struggles to pay down its debt load. Moody’s expects TC’s leverage to amount to more than 5.5 times its earnings before interest, taxes, depreciation and amortization (EBITDA) “for the next few years.”
Although TC Energy’s stock is only now feeling the pain, the company’s woes stretch back a decade, starting with the U.S. shale oil and gas revolution. Around 2011, a technological revolution took hold in U.S. drilling for oil and gas, when new tools allowed producers to unlock oil and gas trapped in rocks in areas such as the Bakken formation in North Dakota. (The U.S. is now the leading oil producer in the world.)
Around the same time, climate change became more prevalent, and then-U.S. president Barack Obama ultimately blocked TC Energy’s plans to build the Keystone XL pipeline that would transport more Canadian oil sands crude to the U.S. That was partly because oil sands crude has a higher carbon intensity than shale oil, but also because the U.S. had become much less reliant on Canadian crude.
Shale gas, meanwhile, changed TC Energy’s traditional playbook. Historically the company made its name shipping gas from deposits in Western Canada to eastern markets via its cross-Canada Mainline system. But the development of the Marcellus formation in the U.S. Northeast, in and around Pennsylvania, changed all that. By 2016, shipper contracts that sent gas east on the TransCanada system had dropped by half.
To adjust, TransCanada hoped to change part of its Mainline network to move oil, instead of gas, through its Energy East project. But those plans were ultimately also killed – in large part because of Quebec’s opposition.
Boxed in, TransCanada acquired Columbia instead, and natural gas pipelines now contribute nearly 80 per cent of TC’s annual EBITDA. This served the company well when natural gas prices soared at the start of Russia’s invasion of Ukraine, nearly sending TC’s share price back to its prepandemic high.
But so much has changed in the past 18 months. After natural gas prices plummeted, the number of drilling rigs in the U.S. started to shrink, which means prospects for more transport volumes on TC’s pipelines are disappearing. And with growth falling away, investors are putting more focus on the company’s balance sheet – especially after the price of Coastal GasLink increased again.
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Late last year, TC Energy tried to calm investors by saying it would sell $5-billion worth of assets in 2023 to help repay debt. The company has also lowered its dividend growth to 3 per cent to 5 per cent a year, down from 5 per cent to 7 per cent.
In an e-mailed statement Tuesday, TC said that the deal “demonstrates our commitment” to reduce debt and strengthen its balance sheet.
“We have advanced our goals by delivering on our $5+ billion asset divestiture program well ahead of our year-end target, while maximizing the value of our assets. While we take into consideration a multitude of perspectives in our business decisions, we remain confident in our disciplined growth plan and long-term outlook.”
However, the sale price of the Columbia stake has analysts concerned. The price tag amounts to 10.5 times Columbia’s EBITDA, while many analysts expected asset sales to be worth 11 to 12 times. Columbia is also a “marquee asset,” according to Bank of Nova Scotia analyst Robert Hope, which means it should have received one of the best multiples currently available.
By comparison, analysts at Toronto-Dominion Bank estimated in 2016 that TransCanada purchased Columbia for 17.6 times earnings.
The good news for TC Energy is that more than 90 per cent of its cash flows come from regulated assets and long-term contracts, so it has reliable revenues ahead.
But the company will have to learn from the oil and gas producers with whom it has swapped places. Funding expansion through debt often seems extremely lucrative – until suddenly it’s very, very painful. And once investors fixate on the balance sheet, winning them back can be a slow and painful process.
TC Energy‘s shares closed at $48.50 on Tuesday, almost exactly where they were when Columbia was first acquired.