Energy infrastructure companies ONEOK (NYSE: OKE) and TransCanada (NYSE: TRP) are both emerging from the energy market downturn as stronger entities. Each made smart acquisitions, with TransCanada buying U.S. gas pipeline company Columbia Pipeline Group, while ONEOK is in the process of gobbling up its MLP,ONEOK Partners (NYSE: OKS). While these deals enhanced the growth profiles of both companies, TransCanada still stands out as the better buy for long-term income investors. Here's why.
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Battle of the balance sheets
The oil market's recent downturn shined a light on the importance of having a solid financial foundation. As the following chart shows, both companies are in pretty decent positions right now:
Data sources: ONEOK, ONEOK Partners, and TransCanada.
TransCanada has one of the highest credit ratings among pipeline companies. While its leverage ratio is much higher than either ONEOK or ONEOK Partners, that's not as much of a concern as it would be for other companies for two key reasons. First, more than 95% of the company's earnings come from regulated assets or long-term, fee-based contracts, which provide very stable cash flow. For comparison's sake, ONEOK Partners only gets 85% of its earnings from fee-based assets. Meanwhile, TransCanada typically pays out less than half its cash flow in dividends each year, using the other half to finance growth projects. ONEOK, on the other hand, pays out nearly all its cash flow, meaning it relies heavily on the capital markets to fund growth projects.
TransCanada's higher credit rating has proven to be a competitive advantage during the downturn. It has had no problem accessing capital to finance growth, raising 11 billion Canadian dollars of capital last year to fund its purchase of Columbia Pipeline Group and other growth projects. ONEOK Partners, on the other hand, avoided accessing the capital markets last year because of higher costs and instead turned to banks for financing. However, ONEOK expects its credit rating to improve to investment grade once it merges with its MLP, which should also reduce its cost of capital. That said, with an A-rated balance sheet, a higher portion of its cash flow coming from stable sources, and a much lower payout ratio, TransCanada's financial position is still better than ONEOK's.
Image source: TransCanada.
Comparing the portfolios
TransCanada is one of the largest energy infrastructure companies in North America. The company operates one of North America's largest natural gas pipeline networks, transporting 25% of continental demand across 56,900 miles of pipeline in Canada, the U.S., and Mexico. In addition to that, it controls a premier liquids pipeline system that transports 20% of the oil exports out of Western Canada. Finally, it is the largest private sector power generator in Canada. Overall, TransCanada operates a world-class portfolio few companies can rival.
ONEOK and ONEOK Partners, on the other hand, are focused on operating pipelines and processing plants in America's mid-section. Further, while ONEOK does own a 37,000-mile network of pipes, these are solely natural gas and NGL pipelines. That said, the company does operate assets across most of the major shale plays in the U.S., with asubstantial footprint in the Bakken and Mid-Continent shale plays.
While ONEOK controls an excellent position in some of America's fastest-growing shale plays, its portfolio doesn't come close to rivaling the size and diversification of TransCanada's.
Image source: Getty Images.
A look at the upside
TransCanada is already an enormous company. However, it expects to continue expanding rapidly over the next few years. The company currently has CA$23 billion of near-term capital projects under development, including $7.1 billion of projects in its U.S. gas pipeline segment thanks to last year's acquisition of Columbia. On top of that, the company has another CA$45 billion of commercially secured long-term projects that are waiting in the wings, such as the recently revived Keystone XL pipeline. Overall, TransCanada expects these projects to fuel dividend growth of 8% to 10% per year through 2020, from a current base rate of 3.7%, with growth likely to come in toward the upper end of that range.
ONEOK also expects to deliver robust dividend growth over the next several years. Upon closing the acquisition of ONEOK Partners, the company plans to boost the payout 21% for 2017, while forecasting 9% to 11% annual growth after that through 2021, with that growth coming off an even higher base rate of 4.6%. While that's faster dividend growth than TransCanada, it's worth noting that the Canadian pipeline giant expects to deliver its growth while maintaining a 50% payout rate compared to the roughly 80% ONEOK expects to pay out each year. That more aggressive payout rate means investors would collect more income over the same timeframe, but it also leaves the company more susceptible to a payout reduction should things not go according to plan.
ONEOK offers investors more income today and a higher growth rate over the next few years. However, that greater reward comes with more risk because it's paying out a much higher percentage of cash flow than TransCanada. Further, ONEOK's financial metrics, portfolio, and long-term growth prospects pale in comparison to TransCanada. That's why, in my opinion, TransCanada is the better buy because it offers income investors clearly visible dividend growth with a much lower risk profile.
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