Encana Corporation: Is it Worth a Shot at $5?

Encana Corporation (TSX:ECA)(NYSE:ECA) looks crazy cheap, but risks still remain.

The Motley Fool

Encana Corporation (TSX:ECA)(NYSE:ECA) is being abandoned by the market, but some investors are wondering if the selloff has gone too far.

Let’s take a look at the situation to see if this is the right time to bet on a recovery.

Cost cuts

Encana recently decreased its 2016 capital program by another 25% and cut the dividend once again. The new quarterly distribution of 1.5 cents per share will require about $50 million in cash flow.

Investors must be asking themselves why management is still paying any dividend at all, but you have to like the fighting spirit.

Encana now plans to spend US$1.5-1.7 billion in 2016, down from the US$2.2 billion last year. With WTI oil now trading below US$30 per barrel, the situation is getting pretty serious, and Encana is focusing 95% of its spending on its four core assets in the Eagle Ford, Duvernay, Montney, and Permian plays. As a result, year-over-year output from those assets is actually expected to increase 12%.

Unfortunately, total production is still going to fall to 340,000-370,000 barrels of oil equivalent per day (boe/d), which is down from the 2015 guidance of 395,000-430,000 boe/d. We will have to wait for the Q4 2015 numbers to come out to see where the company actually finished the year.

The drop in daily production is going to squeeze cash flow, and that means the balance sheet will remain in focus.

Debt issues

Encana started 2015 with long-term debt of about US$7.8 billion and managed to unload about US$2.8 billion in assets throughout the year and raised $1.44 billion through a stock sale. One of the asset sales valued at US$900 million was expected to close by the end of the year, but has been pushed out to some time in the first half of 2016.

The good news for potential investors is the fact that none of the notes are due before 2019, so there is time for Encana to unload more assets and ride out the rout a wee bit longer.

Reducing the dividend and the capital expenditures will definitely help, but the 2016 cash flow assumption of US$1-1.2 billion is looking a bit optimistic right now, even with some hedging positions helping to ease the pain.

In the company’s December 14 update, Encana based the 2016 numbers on WTI average of US$50 per barrel and a NYMEX natural gas average of US$2.75 per MMBtu. WTI oil is now US$29.50 per barrel and natural gas is $2.15 per MMBtu, so a significant rally is badly needed for Encana to hit its targets.

Should anyone buy Encana?

When oil spiked last week, Encana rallied 38% in less than three trading sessions. That’s a serious move over the course of a very short time frame, and it indicates the potential that lies in the energy patch’s walking wounded.

Encana’s debt is an issue, but the company has a fantastic portfolio of assets in some of the industry’s top resource plays. If oil is finally bottoming out, this is probably a good time to pick up the shares because the upside on a recovery is significant.

Another reason to consider the stock is a possible buyout. At the time of writing, Encana has a market cap of about US$3.5 billion. If we assume net debt of about $5 billion, you are looking at US$8.5 billion plus a premium to buy one of the oil patch’s top targets.

The larger players with solid balance sheets could easily pull it off, and the longer oil stays below US$30, the more likely it becomes that someone could take a run at Encana.

The risks are pretty high, but contrarian types might want to start a small position if the stock falls much further.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Walker has no position in any stocks mentioned.

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