With the oil & gas sector hit hard by the steep decline in oil prices, Encana Corporation (ECA, Financial) is no exception. While the stock has declined by just 3.9% YTD14, the stock is down by 29% from 2014 peak levels of $24.6.
Currently, Encana trades at $17.35 and the levels are very attractive in my opinion for long-term exposure to the stock. This article discusses the key investment positives related to Encana that will take the stock significantly higher when oil prices recover.
At the onset, I want to mention that Encana is currently trading at an EV/EBITDA of 3.54 and I believe that these are incredibly cheap levels considering the potential growth that is lined up for the company over the next few years. Therefore, from a valuation point of view, Encana is certainly very attractive. The following section will discuss why Encana is also attractive from a business point of view.
The first positive relates to the company’s swift portfolio transition in 2014 and its implications on the company’s growth. The chart below gives the dispositions and acquisitions in 2014 and the chart also explain the impact of the portfolio transition.
As evident from the chart, the company’s earlier assets had a $20 per BOE netback margin and the acquired assets have a netback margin of $55 per BOE. The lower margin natural gas production has been replaced by the higher margin liquids production in two of the best assets in the US (Permian and Eagle Ford).
The immediate impact o this transition is not evident on the company’s valuation as oil prices have declined steeply. However, when oil prices trend higher (very likely over the next 2 years), Encana will be well positioned to grow at a strong pace through the prized assets.
The company’s acquisition of Athlon Energy, which gives the company exposure to 3 billion barrels of oil equivalent resource potential and a current production of 30,000boepd, is certainly transformative. The acquired asset currently has 5,000 horizontal well locations and this means that the company has a multi-year drilling inventory and production growth potential.
The company expects the Permian asset to be self funding by 2016 and if this happens, the company’s balance sheet will remain robust. The company’s debt maturity schedule is already comfortable with no debt maturities until 2017.
Further, with cash and equivalents of nearly $7 billion as of 3Q14, Encana is certainly well placed in terms of financial flexibility. This has helped the company fund the Athlon Energy acquisition with the current cash on hand.
From a growth perspective, Encana is targeting a 20% CAGR in cash flow per share through 2017. Therefore, the expected growth is robust. However, with 75% of the upstream operating cash flow expected to come from liquids, oil prices need to recover for the company’s assets to exhibit their full cash generating potential.
In my opinion, the oil price decline is overdone and the oil prices are likely to trend higher in 2015 and 2016 as geo-political tensions continue to impact oil prices. Further, a strong dollar is also not sustainable in my opinion and as the dollar weakens, oil prices will move higher. Therefore, decline in oil prices is an opportunity to buy companies with rich assets and Encana has excellent assets after the transformative deal in 2014.
In conclusion, investors can certainly consider Encana at current levels as the stock looks promising for big upside over the next few years. The current weakness in oil prices and the stock is a big buying opportunity and a value buying opportunity when it comes to Encana.
