Spectra Energy's Stock Had a Fantastic 2016. Is There Room to Run in 2017?

By Tyler CroweMarketsFool.com

Few companies in the oil and gas transportation and logistics business can tout the level of success Spectra Energy (NYSE: SE) had in 2016. Then again, there are few companies that are in the same position as Spectra. With a large retinue of projects to capture the wave of surging natural gas production and consumption in the U.S. and a decent looking balance sheet, there's little wonder why Enbridge (NYSE: ENB) decided to pick Spectra as a potential merger partner over any other midstream player.

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Here's the thing, though, it's very rare for a company as large as and in the same business as Spectra Energy to see gains of 66%. So after such a strong performance last year, you have to wonder if Wall Street has outpaced itself with Spectra Energy's stock. So let's take a look at what made 2016 so special for Spectra Energy and whether the company's stock price is right for more gains in 2017.

Image source: Getty Images.

Big returns for being better than the rest

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If you go through Spectra Energy's press releases and quarterly results for the year, there isn't really anything that jumps out as spectacular and should merit such a large jump in stock price by itself. Sure, the company sold some natural gas liquids assets in Canada and won a bid for a $1.5 billion pipeline to deliver natural gas to Mexico. But, these aren't game changing events for a $30 billion oil and gas transportation giant.

What really set this year apart is that Wall Street got wise to the fact that it had a strong balance sheet and a prudent management team; something that isn't necessarily common in this particular industry. A glaring example of this was when oil and gas midstream titan Kinder Morgan (NYSE: KMI) slashed its dividend in late 2015 because it's debt levels were making its creditors uneasy and there was little excess cash to reinvest in the business or pay down debt after paying shareholders.

Spectra Energy, on the other hand, has a quality that few others in this business possess. It has a massive backlog of potential projects. It has brought more than $20 billion in new assets online since 2013. All the while, it has kept a rather modest balance sheet and a dividend growth program that hasn't strained the company's cash flow. Simply being in this position after so many others were exposed by the oil crash in recent years was enough to separate Spectra from the pack to a certain degree.

The other big thing that vaulted Spectra's stock higher this past year was the announcement that both it and Canadian pipeline giant Enbridge were merging in a deal that will create North America's largest energy infrastructure business by a wide margin. For Spectra Energy, it means 0.984 shares of Enbridge per share of Spectra. That day alone represented a large part of this past years gain as shares climbed more than 13% in a single day.

Now that Spectra's shareholders have voted overwhelmingly in approval of the merger, it all comes down to whether or not regulators will approve the merger of Enbridge and Spectra. The one thing that certainly looks to be in the two's favor is that there isn't a whole lot of geographic or service overlap between the two, so there is less concern of monopolistic pricing. The one part of the business where the two have significant overlap is in natural gas distribution in Eastern Canada, but even there it is two disparate geographies.

Image source: Spectra Energy/Enbridge investor presentation.

Still room to run?

It's not a 100% guarantee that the Enbridge/Spectra Energy deal is going to go through. For arguments sake, though, let's assume that it does go through and we need to think of this company as a single entity from here on out. Based on the company's investor presentation and what management projects for the next several years, it looks like a pretty good deal. The combined company will have about $26 billion in capital projects come online between now and 2019 with an additional $48 billion in capital investments under review.

All of these investments are projected to lead to 10%-12% annual dividend growth between now and 2024. That's a pretty long time horizon for any company to be making those kinds of projections, so take it with a grain of salt. That being said, there is a pretty strong growth pipeline that these two companies have to build on for the next several years.

At the same time, though, buying into that growth is going to cost you. Shares of Spectra Energy trade at a pretty significant premium compared to many of its U.S. peers.

Source: Company press releases and S&P Global Market Intelligence.

At that kind of valuation, it's hard to imagine shares of Spectra Energy pulling a repeat performance in 2017.

What a Fool believes

For investors looking for long term bets on North America's oil and gas industry thriving over the next several years, the combination of Enbridge and Spectra Energy look to be a great way to do just that. One word of caution is that the deal hasn't been completed. If for some reason the merger were to fall through, Spectra would have to shell over $1 billion in cash to Enbridge. So if there is even a whiff of it not happening, that may be enough to prevent investors from jumping into this stock with reckless abandon.

At today's valuation, any investor needs to be looking at the very long term. Returns for the next year or two might not be as good because of the overly optimistic share price, but management's promises of strong dividend growth well into the 2020s might be enough to make this company worth a look.

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Tyler Crowe owns shares of Enterprise Products Partners and Magellan Midstream Partners.You can follow him at Fool.comor on Twitter@TylerCroweFool.

The Motley Fool owns shares of and recommends Kinder Morgan, ONEOK, and Spectra Energy. The Motley Fool recommends Enterprise Products Partners and Magellan Midstream Partners. The Motley Fool has a disclosure policy.