It must feel good when your stock trades up 4.4% on the day that you host your analyst meeting. Executives are excited that investors like their plan for the future, IR personnel are happy that their presentation conveyed that plan effectively, and employees are enthusiastic about having a plan that they can get behind. What did Spectra Energy Corporation (SE) CEO Greg Ebel and his team do right? Let’s take a look (slide presentation here).
The Earth at Night map is both stunning and informative (additional evidence available here courtesy of the Suomi NPP). But what does that have to do with Spectra? A lot, when you overlay the company’s asset footprint and include the statement, “We go where the lights are.” Because the lights are generally concentrated in metropolitan areas, i.e. demand centers, and few expect energy demand to stop growing anytime soon, the implication is that SE’s plan to grow its dividend by 8%-9% per year through 2017 is secure because it is not dependent on the supply of US oil production continuing to grow and/or commodity prices rebounding.
The skeptic might point out on the second slide that Spectra is planning to grow its dividend over the next few years not by generating more distributable cash flow, but by taking its coverage ratio down to 1.0 times, leaving little room for error. That means regulatory approvals need to be secured and projects need to be completed on time and on budget at Spectra Energy Partners (SEP). Volumes need to meet expectations on fee-based contracts. And the loonie needs to strengthen a bit against the US dollar. So why don’t investors seem to be more concerned? Because the whole point of having a coverage ratio is to protect the company from events within two standard deviations, not for it to be constant throughout the business cycle. If a company stays meaningfully above 1.0 times in stress tests like the current environment, management might want to consider paying out more cash to investors. If coverage falls below 1.0 times, management likely wasn’t conservative enough in its scenario analysis.