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The Forgotten Crown Jewel

By Ari Charney on September 9, 2016

While Wall Street is knee deep in the hoopla over the Enbridge-Spectra mega-merger, Spectra Energy Partners LP (NYSE: SEP), the crown jewel of Spectra’s midstream natural gas empire, seems to have been largely forgotten.

But even before the deal’s announcement, SEP’s units had been languishing, especially compared to the impressive rebound staged by its sponsor.

On a year-to-date basis through Sept. 2, the day before Enbridge announced the merger, SEP’s unit price was down 4.7% compared to a 51.0% gain for Spectra Energy Corp. (NYSE: SE).

That’s a stark contrast to last year when the relatively conservative, demand-facing SEP was one of the few midstream firms that did a decent job of holding its value amid the sector’s crash. Although SEP’s unit price declined 16.3% last year, that performance was vastly superior to Spectra’s 34.1% drop and the Alerian MLP Index’s 37.0% decline.

Since the deal’s announcement just before the market’s open on Tuesday, shares of the parent have climbed another 18.5%, compared to a further 4.0% decline for SEP.

Even Enbridge’s (NYSE: ENB, TSX: ENB) stock is up since the deal’s announcement, about 8.7%, which is unusual since acquirers typically see their share prices take a short-term hit.

What gives? The major reason why Spectra and SEP have headed in opposite directions since the deal’s announcement is that MLP unitholders get jittery whenever another entity assumes control of the general partner.

The primary concern is that the MLP subsidiary will be left to languish, especially given the fact that, in this case, Enbridge already has its own MLP, Enbridge Energy Partners LP (NYSE: EEP), as well as other similarly positioned subsidiaries, not to mention the fact that it’s already in the midst of a strategic review for both EEP and another entity.

Given the circumstances, SEP’s unitholders are clearly worried that distribution growth could start to flat line, as the parent company’s attention and asset dropdowns are directed elsewhere. Since MLPs are essentially yield vehicles, their unit prices tend to stagnate in the absence of distribution growth.

There certainly have been other instances of so-called orphan MLPs. However, that’s unlikely to be the case for SEP, mainly because of its superior cost of capital. SEP is simply too valuable for Enbridge to let it whither on the vine.

Indeed, management clearly listed SEP’s at-the-market issuance program as one of the top sources of equity to finance its capital plan.

During the analyst call to discuss the transaction, Enbridge CFO John Whelen noted that they’ll be “drawing heavily on the capacity of those vehicles (i.e., subsidiary MLPs such as SEP) to raise capital.”

But while management was largely mum about its plans for SEP otherwise, they clearly intend to consolidate a couple of their other midstream subsidiaries. That could mean that EEP, which mostly holds Enbridge’s U.S. based energy infrastructure, might get rolled up into SEP at some point down the line.

However, analysts believe that Enbridge will likely take pains to avoid doing anything that could undermine SEP’s superior cost of capital. EEP, for instance, might not be a good fit for SEP because its assets are largely oriented toward crude oil.

Beyond that, it stands to reason that SEP will actually benefit from a larger inventory of potential asset dropdowns, especially given its status as one of the sprawling empire’s preferred funding vehicles.

Even so, while we can infer some of management’s near-term intentions for SEP, we can’t know for certain what their longer-term plans are, which means that there is more risk now for the MLP than there was previously.

But with SEP’s forward yield of 6.1%, that’s probably a risk with which most income investors would be willing to live.

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