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Should Encana Corporation Be Your Top Oil Rebound Pick?

Oil prices have moved significantly higher in recent weeks and investors are starting to wade back into some of the sector’s walking wounded in hopes of riding the oil rebound to big gains.

Let’s take a look at Encana Corporation (TSX:ECA)(NYSE:ECA) to see if it deserves to be in your portfolio.

In transition

Encana is in the midst of the energy sector’s largest transformation as it moves from being a slow moving, bloated, natural gas elephant to a slim, nimble oil-and-gas-liquids jaguar.

Well, that’s the objective at least.

Right now, the whole transition process looks like a case of bad timing. The company has taken a lot of heat from analysts and investors for some of its moves. The largest deal to date, the US$7.1 billion acquisition of Athlon Energy Inc. closed in late 2014, but was negotiated when oil was still trading at very high levels.

Last June Encana’s stock was worth $26 per share. Today it’s at $17.

Cash flow shortfall

In the Q4 2014 earnings statement, Encana reduced its already lowered 2015 capital expenditure program to $2-2.2 billion in order to accommodate the difficult conditions in the market.

The new guidance assumes an average WTI price of $50 per barrel (bbl) for the year and NYMEX natural gas prices of $3 per million British thermal units (MMBtu). Total cash flow for the year is expected to be $1.4-1.6 billion.

The company is using proceeds from dispositions to fill the $800 million funding gap and cover its dividend. Normally, it isn’t a great idea to sell revenue-generating assets to cover a cash flow shortfall, but these are lean times in the patch.

In March Encana raised $1.44 billion through a bought deal share offering. The company plans to use the proceeds to redeem long-term debt that is maturing in 2017 and 2018.

This is a smart idea considering Encana had a total of US$7.8 billion in long-term debt at the end of 2014 and another US$4.7 billion in other long-term liabilities.

That’s a heavy load for a company with a market capitalization of $12.6 billion.

Should you buy Encana?

Oil prices are now trading at $57/bbl, which is why the stock has rallied more than 20% in the past month. Natural gas isn’t faring as well, lingering below $2.50/MMBtu.

If oil prices have bottomed, Encana has a shot at making it. Otherwise, the huge debt load could force management to cancel the dividend, issue a bucket-load of stock, or sell off the rest of the family jewels at pawn-shop prices.

None of this is good for shareholders.

At this point, I would avoid the stock. There are better names with stronger balance sheets that will also rally if oil continues to recover.

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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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