Crude prices are near a one-year low, natural gas cheaper than a decade ago and the controversial Keystone XL pipeline still blocked by legal challenges and politics.

But none of this has stopped TransCanada’s (NYSE: TRP, TSX: TRP) share price from zooming to a record high this week. The gains have been driven by strong results, attractive growth opportunities and a 3.2% yield that lets the Canadian pipeline giant retain much of its swelling cash flow.

This rally on recently heavy turnover has much further to go, and we’re going to come along for the ride. We’re adding TRP to our Conservative Portfolio.

The fundamental case for TransCanada starts with some geology and geography.  Although Canada is often lumped with the US in analyses of the North American oil production boom, it is a major crude producer and exporter in its own right.

This year’s estimated output of 3.7 million barrels per day (bpd) will roughly equal the combined production of Texas, Alaska and California. Two-thirds of that will be exported to the US, which remains the only significant importer of Canadian crude. US imports have been steadily shrinking thanks to the shale drilling boom, but so far not at Canada’s expense. Canada now supplies a third of US oil imports, up from a quarter three years ago.

And while Texas is within easy reach of many US refineries, Canadian crude exports must travel thousands of extra miles to their destination, whether by existing pipeline, train or the new Keystone XL route pushed by TransCanada.

Environmental opposition to Keystone XL hasn’t halted alternative pipeline plans amid expectations for significant growth in Canadian oil production. Among them is TransCanada’s planned Energy East pipeline that would deliver Alberta crude to Canada’s Atlantic coast. Other midstream operators are working on links to Pacific ports from which Canada’s crude surplus could be exported to Asia.


Source: TransCanada presentation

In the meantime TransCanada is making a very nice living off its bread and butter business transporting natural gas, thanks to the booming output of shale gas in Western Canada. Gas transportation profits were up 18% year-over-year in the most recent quarter, and accounted for 62% of TransCanada’s total. The rest was split almost equally between crude and power generation.

In the first half of 2014 revenue increased 20% year-over-year, while funds from operations excluding changes in working capital rose 8%.

The dividend has also increased 8% year-over-year, and at a current yield of 3.2% is competitive with those paid by the corporate parents of the largest US midstream operators. It’s taxed at a qualified dividend rate as low as 15%, and as such is suitable for IRAs.

The yield is not as rich as that of comparably growing US MLPs, and is not tax-deferred. But, on the other hand, the dividends use just a third of TransCanada’s cash from operations. If the company paid out most or all its cash earnings like US MLPs the yield would verge on double-digits. Very few midstream MLPs could do the same, and TransCanada is considerably cheaper than US midstream operators, corporate or MLP. For example, its enterprise value (market cap plus debt) is 12 times the estimated 2015 EBITDA (earnings before interest, taxes, depreciation and amortization.) As Barron’s noted recently in its own bullish article on TransCanada, Kinder Morgan (NYSE: KMI) currently trades at an EV/EBITDA closer to 16.

That might be because KMI’s yield based on next year’s forecast dividend at the current price is 5.2%. Investors are still willing to pay up for income.

But what TransCanada won’t be paying out as dividends will be available to invest in a slate of pending projects with an aggregate cost of $34 billion, including the $11 billion Energy East link that has already secured commercial commitments, two links from TransCanada’s extensive Alberta gas network to  planned liquefied natural gas (LNG) terminals on Canada’s Pacific Coast and, of course, the Keystone XL.

TransCanada does have some exposure to changing gas consumption patterns, and gas from the Marcellus and the Utica deflates demand for its pipes carrying Alberta and Gulf Coast gas to the Midwest. The company has responded by repurposing some of the system to carry Marcellus and Utica gas to consumers, and cutting costs and renegotiating tariffs on the rest. TransCanada has committed to dropping down the US portion of its gas network to its affiliated MLP, TC Pipelines (NYSE: TCP) over the next several years. That should provide a steady flow of additional cash from dropdowns at the attractive multiples US MLPs fetch these days, money TransCanada can reinvest in more promising projects on its home turf.


Source: TransCanada presentation

Which brings us back to geology and geography. Canada is vast, its oil industry is far more dependent on exports than the US, and the US is currently the main outlet for virtually all of Canada’s surplus oil and natural gas. This is set to change in the coming years as producers seek improved access to the higher-value global markets, and TransCanada will be a huge part of that effort. It has the financial and managerial resources to make the most of that opportunity.

Given the run-up of recent weeks, a quick correction isn’t out of the question. But there’s no need to wait, and any pullback would be a buying opportunity. Buy the NYSE-listed shares of TRP below $62.