Better Buy: TransCanada Corporation vs. The Williams Companies Inc

By Matthew DiLallo Markets Fool.com

Williams Companies (NYSE: WMB) and TransCanada (NYSE: TRP) share many similarities. Both generate most of their income from operating fee-based natural gas pipelines, which gives them steady cash flow to support dividends. Speaking of that, both have similar yields, though at 4% Williams' current payout slightly edges out TransCanada's 3.7% yield. That said, as we drill down a little deeper it becomes clear that TransCanada has a few advantages over Williams, which for conservative investors makes it the better buy. Here's why that's the case.

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The financial checkup

One thing that gives TransCanada an edge over its U.S. gas pipeline rival is its financial strength:

Company

Credit Rating

Debt-to-Adjusted EBITDA

Current Dividend Coverage Ratio

% of cash flow fee-based or regulated

TransCanada

A

5.8 times

2.1 times

95%

Williams Companies

BB+/Ba2

5.25 times

1.3 times

97%

Williams Partners

BBB-/Baa3

4.5 times

1.2 times

97%

Source: Williams Companies, Williams Partners, and TransCanada.

As that chart shows, TransCanada has an A-rated balance sheet whereas Williams has junk-rated credit. One reason TransCanada has such a high credit rating is due to its conservative dividend coverage ratio since the company typically retains more than half its cash flow to finance growth projects. Further, more than 95% of its cash flow comes from stable fee-based or regulated sources, which enhances its financial security.

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That said, Williams Companies' financial situation has improved dramatically over the past year. It's MLP Williams Partners (NYSE: WPZ) has jettisoned several assets with commodity price exposure, which has increased the combined company's percentage of cash flow from fee-based sources from 93% to 97%. In fact, Williams Partners' latest deal recently led one of its credit rating agencies to say that the company is in line for a two-notch credit rating upgrade to BBB+. Meanwhile, through a combination of strategic transactions, Williams Companies has shored up its financial situation and intends to use the excess cash flow it will generate this year to reduce debt.

That said, with a top-tier credit rating and conservative dividend coverage, TransCanada's finances are stronger than Williams.

Image source: Getty Images.

A pipeline of future growth

The other thing that gives TransCanada an edge over Williams Companies is the visibility of its future growth. Currently, the company expects to deliver annual dividend growth of 8% to 10% per year through 2020, with increasing confidence that growth will likely come toward the upper end of that range. Fueling that forecast is the fact that TransCanada has 23 billion Canadian dollars' ($17.1 billion) worth of near-term capital projects under construction that should enter service by 2019. On top of that TransCanada has CA$45 billion of long-term projects under development that should extend dividend growth well into the early part of next decade.

Williams Companies, meanwhile, expects to grow its dividend at a faster clip of 10% to 15% annually "over the next several years." While that's a higher projected rate than TransCanada, the length is a bit vague. That said, the company does have good visibility into growth since Williams Partners has $5.5 billion of near-term expansion projects on its key Transco system underway. That positions the MLP to increase its distribution by 5% to 7% annually over that same timeframe, which should give Williams Companies the incremental cash flow it needs to support its growth forecast. Meanwhile, Williams is pursuing nearly two dozen additional growth projects across its system to extend its growth further into the future. That said, the company's commercially secured backlog pales in comparison to TransCanada's.

Investor takeaway

Williams Companies is a solid pipeline stock to own for the long-term because improvements at its majority-owned MLP means the company has clearly visible growth ahead of it. However, TransCanada takes things up a notch thanks to its stronger financials and bigger commercially secured backlog. That's why I'd buy TransCanada's stock over Williams right now.

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.