Every once in a while investors will find companies that show great prospects for success, but which gurus have not purchased stock of. Analysts praise the company because of how good things are going, and delineate a business strategy so juicy that one begins to wonder. A clear example of this is Spectra Energy (SE), described by an analyst as “an energy company that is blessed with strong growth prospects, a fast dividend growth rate, and a very strong balance sheet.” But, does it mean that purchasing the stock is a good investment? He thinks so when saying things like, “It would make a fine addition to any income investor's portfolio.” If so, why have five gurus dropped the stock during 2013?
Pumping Up the Stock
Some of the most common advice given to junior investors in the market is: If you cannot understand how the business makes money, do not buy stock of it. This is clearly the case for Spectra Energy. The same analyst goes on through several lines explaining how the firm drops assets to obtain cash and reduce debt, in order to borrow again and consequentially improve income. That may be true and work out to material growth, but it is surely with a risk that may be concealed behind a juicy annual yield of 3.63%.
Before addressing the risks associated with such a business model, let us look at what financial institutions expect from Spectra Energy. CIBC raised the stock’s target price by $1 to $37, while Citigroup lifted it by $2 to $47, and analysts at Argus have pumped the figure by $3 to $41. So far, four investment analysts have rated the company’s stock with a “Hold” rating and five with a “Buy” rating.
On the company’s side, announcements have been made about new projects: first, the submission of an Environmental Assessment Certificate Application (Application) for its Westcoast Connector Gas Transmission Project to the BC Environmental Assessment Office. Additionally, management made public the Atlantic Bridge project, a proposed expansion of its Algonquin Gas Transmission and Maritimes & Northeast Pipeline systems. Both projects are evidence of organic growth that feeds into the prospects for growth theory.
Kicking the Ballistics
Two projects cannot back impressive growth for any company, unless the projects entail a restructuring of the business model, or absorb some out of the ordinary market synergy. It is not necessary to say that neither case applies to Spectra Energy, and why are analysts so hyped about the company’s future? Their recommendations are mostly based on a planned $25 billion in new projects and acquisitions over the next 10 years.
The question that remains is how the money will be raised. To answer the question one has to unveil the financial trickery through which the company drops assets to subsidiaries in order to leverage debt, for which it obtains cash in exchange, and better positions itself for borrowing. However, for the whole system to work there are a few conditions that must be met.
For Spectra Energy to execute the planned investment, fluctuations in the natural gas market must be contained. Management will have to address weak commodity prices that affect earnings at its Empress fractionator and DCP Midstream joint venture. Additionally, operations in Canada need to be locked away from currency fluctuations, while curbing regulated tariff rates and an unfavorable macro environment may result in lower earnings and cash flows.
Currently trading at 23.8 times its trailing earnings, Spectra Energy’s stock carries a 39% discount to the industry average. Most importantly, debt levels continue to rise while revenues and net income have found a ceiling. Most importantly, only algorithmic Technology Renaissance has repurchased stock from the company in a deliberate attempt for rewards in the short term. Hence, long-term prospect investors are recommended to stay away from the company.
Disclosure: Vanina Egea holds no position in any of the mentioned stocks.