Spectra Energy Partners, LP (NYSE:SEP) is in for challenging times. In its quarterly report on earnings, the company revealed that it took both a revenue and an earnings hit relating to the recent tax reform act. Although the company will move on from that one-time charge, it faces an environment of falling profits. Now, the downstream natural gas and oil company must find a way to increase profits to keep the increasing stream of dividends flowing from SEP stock.

A Non-Cash Charge Wiped Out SEP Stock Earnings and Revenue

The Houston-based master limited partnership missed estimates by a wide margin. It reported an earnings-per-share (EPS) loss of $1.86. Analysts had been looking for EPS of 84 cents. The company earned 70 cents per share in the fourth quarter of 2016.

Revenues came in at -$138 million, a miss of $861.1 million. The negative revenue and earnings numbers stemmed from a non-cash $860 million charge related to the recent Tax Cuts and Jobs Act. This left annual revenues for 2017 at $1.95 billion, down from $2.533 billion in 2016. Net income for the year came in at 77 cents per share, down from $2.84 per share for 2016.

Spectra spun off from Duke Energy Corp (NYSE:DUK) in 2006 and is now owned by Canada-based Enbridge Inc (USA) (NYSE:ENB). It owns more than 15,000 miles of natural gas pipeline in North America, 170 billion cubic feet of storage space for natural gas and 5.6 million barrels worth of space for crude oil storage.

Falling Profits Endanger SEP Stock’s High Dividend

Its pipeline and storage assets create a vehicle for cash flow. Consequently, dividends remain the one area where SEP stock stands out. This quarter will mark 41 consecutive quarters where the company has increased the dividend. The current quarterly dividend stands at 73.875 cents per share, bringing the dividend yield to about 7%.

The one potential problem I see with the dividend is the payout ratio is creeping dangerously close to 100%. The company earned 77 cents per share in 2017. However, the company paid $2.83 per share in annual dividends. This means the company paid out in dividends nearly four times net income! Even against the expected net income of $2.83 (which wasn’t affected by the $860 million non-cash charge), that amounted to a payout ratio of 81.5%. Unfortunately, analysts project income to continue to fall from 2016 levels. By 2020, consensus estimates place earnings at $2.91 — almost the level of the current dividend.

If the dividend starts outpacing net income, a lack of cash will force the company to either sell assets to maintain the dividend or cut the dividend. Cutting the dividend will have a negative impact on the stock price for a time, but at least it would help the company prevent asset sales and remain solvent.

Unfortunately, the company’s main commodity, natural gas, has not enjoyed the gains seen in the crude oil market over the last two years. After more than doubling in value in 2016, natural gas fluctuated and fell back. After briefly spiking above $3.60 per MMBtu at the beginning of 2018, it trades at under $2.60 per MMBtu today. That’s still higher than the early 2016 level of about $1.70 per MMBtu, but it stands well under crude oil’s rate of increase. With the company unable to gain further traction on pricing, increasing profits — and, by extension, the stock price and the dividend — remains difficult.

Bottom Line on SEP Stock

Although a 7% dividend that’s increased every quarter appeals to investors on the surface, falling profitability threatens the stability of that dividend. A non-cash charge related to tax reform took both revenues and earnings into negative territory. This one-time charge reflects poorly on the previous quarter, but will ultimately benefit SEP stock with lower taxes.

The main worry remains falling profits in future years related to natural gas prices that continue to stay low. The streak of 10+ years of dividend increases now threatens net income. As a result, the stability of the dividend has come under threat.

Spectra owns some valuable pipeline assets and could be a good play with a stable dividend. However, until a dividend cut or a path to higher profitability becomes visible, investors should look elsewhere for dividend income.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks.