Spectra Energy is one of the largest natural gas midstream companies in North America. It owns more than 19k miles of transmission and about 8% of US storage capacity. The company is the result of Duke Energy K splitting itself up with Spectra Energy retaining Duke’s natural gas business. I put the company in my investment pipeline as it is rated 5-star with a wide moat by Morningstar. The company’s stock currently trades for $22-23

1- Business Performance Risk

Metric	Status
FCF / Sales	Last twelve months (LTM): 9.8%, lower than 2009 performance at 17%, but higher than ‘08/’07 performance in the 5%-6%
ROE	LTM: 13.8%, similar to experience over the previous couple of years
ROA	LTM: 4.0%, in line with previous years performance ranging between 3% and 5%
Revenue Growth	Over the last 3 years, the business grew 5% overall but revenue appear to be highly cyclical, with a drop of 10% in 2009, an LTM performance of +13%
Cash distribution to shareholders	Very high dividend yield of 4.5% on a payout of 65-70%! The number of outstanding shares as increased on the market, diluting shareholder, by ~2% over the last 3 years.

The company’s performance may be good for an energy company but still appears a bit too cyclical for me. In addition while ROE has been acceptable, I find ROA’s too low.

In terms of returns, SE pays more than 60% of earnings in dividends (I prefer companies to stay below a 50-60% payout ratio). In addition to dividends, the company would need the reminder of earnings to finance a 5% growth (using a 15% ROE) and would thus not have money to do buybacks. It actually turns out that with free cash flow being less than net income, SE has and will have to add more shares in the future to continue paying its dividend and financing its growth.



2- Balance Sheet Risk

Metric	Status
LT Debt / Equity	1.2x, in line with previous 3 years
Current Ratio	0.5x, in line with previous 3 years

Quite a bit of debt and a very low current ratio albeit in line with previous levels. This B/S seems too risky for my taste.

3- Valuation Risk

Metric	Status
Cash Return	1.9%
P/E	14.4x, in line with the S&P at 13.7x, and below industry average of 16.8x

Spectra energy appears to be somewhat richly valued, with very low cash returns at 1.9% (below a 10-year bond coupon!).

Conclusion

Cyclical business with low returns, highly levered balance sheet and far from being cheap with average P/E and very low cash returns. No thank you!

Have you looked at SE recently? What was your conclusion?

You can find more one-page “Stock Reviews” as well as more in-depth “Stock Analysis”, including a pdf-ed copy of my spreadsheets on my blog: Margin of Safety Investing.

Many happy returns!

Ben

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