We maintain our Neutral recommendation on Spectra Energy Corporation (SE) given its impressive fourth quarter results, continued organic investments, healthy natural gas liquid (NGL) fundamentals, new prospects as well as a revival in the economy. However, we remain concerned about the low natural gas price environment.
Last quarter, the company reported better-than-expected results owing to solid growth from expansion projects that came online, higher commodity prices and a stronger Canadian dollar.
Spectra plans to deploy $1 billion annually through 2015 on fee-based gas infrastructure growth projects, which we expect to meet or beat Spectra’s targeted 10–12% return on capital employed. Notably, with these significant investments, Spectra expects to see annual operating income in the range of $500 million to $600 million.
Importantly, the company expects its adjusted earnings guidance to remain at $1.65 for 2011. However, given its broad pipeline of growth projects and strengthening commodity fundamentals, we believe the guidance may prove conservative. We expect strong returns, particularly on its western Canadian assets, driven by the restart of inoperative capacity around the lucrative Horn River and Montney areas of British Columbia.
We believe Spectra will benefit from its widespread pipeline portfolio given new gas supply possibilities, mainly in Haynesville, Eagle Ford and Marcellus, along with surging demand in Northeast. Accordingly, the company remains committed to approximately $1.8 billion of expansion capital in Northeast. For this year, the company expects about 80% of its margins to come from liquids-rich areas. We also expect superior growth opportunities at DCP Midstream given strong NGL pricing and drilling in liquids-rich areas.
However, we remain on the sidelines as the Field Services business of the company is tied with natural gas, making results vulnerable to fluctuations in natural gas markets. Moreover, Spectra’s relatively debt-heavy balance sheet (with debt-to-capitalization ratio of 54.5% in the fourth quarter of 2010) is a competitive disadvantage.
Houston, Texas-based Spectra, along with its subsidiaries and equity affiliates, is a leading pipeline and midstream gas player engaged in the ownership and operation of a portfolio of complementary natural gas-related energy assets. The company transports natural gas to most major markets in North America. Major competitors of Spectra include Energy Transfer Partners (ETP), Energy Transfer Equity (ETE), Nustar Energy (NS) and Buckeye Partners (BPL).
The company holds a Zacks #3 Rank, which is equivalent to a short-term Hold rating.
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