TC Energy's (TRP) Liquids Pipeline Spin-Off Creates New Player

TC Energy Corporation TRP, a major North American energy sector player, received its shareholder approval to spin off its liquids pipeline business. This strategic move is expected to result in the formation of a new entity, South Bow Corp, which would inherit TRP's extensive liquids pipeline assets, including the renowned Keystone pipeline. This spin-off is aimed at reducing the substantial debt of TC Energy and sharpening its focus on natural gas transportation.

Overview of the Spin-off

Creation of South Bow: South Bow, the newly formed energy infrastructure company, would own nearly 4,900 kilometers of liquid pipelines. These pipelines are critical for transporting oil from Alberta, Canada and parts of the United States to key refining markets in Illinois, Oklahoma and Texas. The centerpiece of South Bow's assets is the Keystone pipeline, capable of transporting 622,000 barrels of oil per day, making it a vital conduit for Canada’s crude exports.

Strategic Benefits for TC Energy: The spin-off is strategically designed to allow TC Energy and South Bow to maximize the value of their respective assets. TRP's CEO, Francois Poirier, emphasized that this separation enabled each company to focus on distinct strategies and opportunities. TC Energy is expected to concentrate on putting more effort into its natural gas business, which is a core component of the company's growth plans.

Financial Implications

Debt Management and Financial Health: One of the primary motivations behind the spin-off was to manage TC Energy's high debt load. By offloading C$7.9 billion (approximately $5.78 billion) of debt to South Bow, TRP aims to strengthen its balance sheet. This strategic financial maneuver could enhance TC Energy's ability to invest in natural gas infrastructure and other growth initiatives.

Revenue Stability for South Bow: Despite inheriting a substantial debt load, South Bow is positioned to generate stable revenues attributed to long-term shipping contracts. These contracts covered 94% of the capacity on the Keystone pipeline, ensuring a steady income stream. This financial stability is crucial for South Bow as it navigates the competitive landscape of the energy sector in North America.

Market Position and Competitive Landscape

South Bow's Asset Base: South Bow's portfolio consists of extensive and strategically significant pipeline assets. Nearly 4,900 kilometers of pipelines connect key oil supply regions with major refining markets, providing a key link in the energy supply chain. The Keystone pipeline, in particular, is a critical asset, known for its capacity and reliability in transporting Canada’s crude to the United States.

Competitive Challenges: However, South Bow faces competition from other pipeline companies looking to expand their shipments to the U.S. Gulf Coast market. The company's narrow asset base and lower growth forecast compared to TC Energy could impact its valuation. Analysts, including Ben Pham from BMO Capital Markets, noted these potential challenges in recent research notes.

Leadership and Future Plans

New Leadership for South Bow: Bevin Wirzba, currently TRP's executive vice-president of Liquids Pipelines, is set to become the CEO of South Bow. His leadership is expected to bring continuity and deep expertise to the newly formed company. Wirzba's experience within TC Energy's liquids pipelines division positioned him well to navigate South Bow through its initial phase as an independent entity.

Legal and Market Transition: The legal separation of TC Energy and South Bow is scheduled for autumn. Following the spin-off, South Bow would be listed on the Toronto and New York stock exchanges. This dual listing is anticipated to enhance the company's visibility and access to capital markets.

Market Analysts' Perspectives

Potential Takeout Candidate: Before finalizing the decision to spin off the liquids pipeline business, TRP engaged in discussions with two other energy infrastructure companies about forming a joint venture. This background suggested that South Bow might be viewed as a potential acquisition target while trading independently. According to Scotiabank analyst Robert Hope, this possibility added an interesting dimension to South Bow's market prospects.

Valuation Considerations: Analysts are closely watching how South Bow's valuation will unfold. The company's narrower asset base and focused operations on liquid pipelines could influence its market performance. However, the stability provided by long-term contracts and the strategic significance of its assets, especially the Keystone pipeline, should act as strong factors that could support a favorable valuation.

Conclusion

The spin-off of TC Energy's liquids pipeline business into South Bow represents a significant strategic shift for both entities. For TC Energy, this move is expected to streamline its operations and focus on core natural gas business, while addressing its debt load. For South Bow, inheriting extensive pipeline assets and securing long-term revenue contracts would position it well for stable financial performance, despite the competitive challenges it might face. South Bow's transition and performance will be monitored slowly as it begins trading as a standalone company.

Zacks Rank and Key Picks

Currently, TRP carries a Zacks Rank #3 (Hold).

Investors interested in the energy sector might look at some better-ranked stocks like Archrock, Inc. AROC and SM Energy Company SM, both sporting a Zacks Rank #1 (Strong Buy) at present, and Sunoco LP SUN, carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Archrock is valued at $3.04 billion. The company currently pays a dividend of 66 cents per share, or 3.39%, on an annual basis.

AROC, together with its subsidiaries, works as an energy infrastructure company in the United States. The company operates under two segments — Contract Operations and Aftermarket Services.

Denver, CO-based SM Energy is valued at $5.46 billion. The company currently pays a dividend of 72 cents per share, or 1.52%, on an annual basis.

SM, an independent energy company, engages in the acquisition, exploration, development and production of oil, gas and natural gas liquids in the state of Texas.

Sunoco is valued at $5.13 billion. It is a major wholesale motor fuel distributor in the United States, distributing over 10 fuel brands through long-term contracts with more than 10,000 convenience stores, ensuring consistent cash flow.

SUN’s extensive distribution network across 40 states provides a robust and reliable source of income and the Brownsville terminal expansion should add to its revenue diversification.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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