TC PipeLines LP (NYSE:TCP) is a company I’ve been following for a while, and although it’s currently trading below its fair value, I have reasons to believe it may not actually reach this figure. My concerns are mainly around the sustainability of its future growth, the opportunity cost of investing in the stock accounting for the returns I could have gotten in other peers, and its cash-to-debt management. Whether a company has a good future, in terms of its business operation and financial health, is an important question to address.
TC PipeLines, LP acquires, owns, and participates in the management of energy infrastructure businesses in North America. Since starting in 1998 in United States, the company has now grown to a market cap of US$1.84B.
The first thing that struck me was the pessimistic outlook for TCP. A consensus of 6 US oil, gas and consumable fuels analysts covering the stock indicates that its revenue level is expected to decline by -5.44% by 2020, putting pressure on expected future earnings, with its year-on-year growth rate estimated to underperform the industry average growth (1.61% vs. 9.83%). When revenues are declining and earnings growth are lagging the industry, there is high uncertainty around the sustainability of its current operations.
Minimizing the downside is arguably more important than maximizing the upside. Generally the first check to meet is financial health – a strong indicator of an investment’s risk. Two major red flags for TCP are its debt level exceeds equity on its balance sheet, and its cash from its core activities is only enough to cover a mere 16.24% of this large debt amount. Furthermore, its debt-to-equity ratio has also been increasing from 52.80% five years ago. Although, EBIT is able to amply cover interest payment, cash management is still not optimal and could still be improved. Or the very least, reduce debt to a more prudent level if cash generated from operating activities is insufficient to cushion for potential future headwinds. The current state of TCP’s financial health lowers my conviction around the sustainability of the business going forward. TCP has high near term liquidity, with short term assets (cash and other liquid assets) amply covering upcoming one-year liabilities. TCP has managed its cash well at a current level of US$68.00M. However, more than a fifth of its total assets are physical assets and inventory, which means that in the worst case scenario, such as a downturn or bankruptcy, a significant portion of assets will be hard to liquidate and redistribute back to investors.
TCP is now trading at US$25.50 per share. With 71.31 million shares, that’s a US$1.84B market cap – which is too low for a company that has a 5-year free cash flow cumulative average growth rate (CAGR) of 7.46% (source: analyst consensus). Given the consensus 2018 FCF level of US$262.82M, the target price for TCP is US$30.45. This means the stock is currently trading at a meaningful 16.26% discount. Also, comparing TCP’s current share price to its peers based on its industry and earnings level, it’s undervalued by 91.90%, with a PE ratio of 7.4x vs. the industry average of 14.2x.
A good company is reflected in its financials, and for TCP, the financials don’t look good. This is a fast-fail analysis, which means I won’t be spending too much time on the company, given that there is a universe of better investments to further research. For all the charts illustrating this analysis, take a look at the Simply Wall St platform, which is where I’ve taken my data from.