It has been a rough year for Encana Corporation (TSX:ECA)(NYSE:ECA) as its stock is down more than 30% due to the weakness in oil prices. However, an analyst at Morgan Stanley sees much better days ahead. That analyst gave the company a US$18 price target, which represents quite a bullish outlook given the company’s current US$14 stock price.
Heading in the right direction
In upgrading the stock to overweight and giving it the US$18 price target, the analyst sees the potential for strong stock gains for investors. The reason for this, according to the analyst in the upgrade report, is the fact that Encana’s asset base is improving as the company focuses on liquids production.
In fact, Encana is expected to move from producing just 10% liquids as of 2013 to 40% liquids by the end of next year. That’s important for profitability as liquids production carries higher margins than natural gas, despite the fact that oil and NGL prices are much weaker today than they were when Encana started its switch in 2013.
Overall, Encana is expected to grow its liquids output by the fastest rate among its peer group. That rapid growth will quickly improve the company’s profitability, even if oil prices don’t budge because of how weak natural gas margins are right now. So, as long as oil prices don’t weaken materially, Encana is in a good position to drive meaningful growth.
Catalysts on the horizon
On top of the meaningful organic growth Encana also has a couple of catalysts on the horizon that could provide a further boost. The company already has a pretty solid balance sheet as its net debt-to-cash flow ratio is expected to be 3.4 times in 2015 and an even better 2.6 times in 2016, which is expected to be better than the peer average of 2.8 times in 2016.
However, the balance sheet could improve further if the company moves ahead with a number of asset sales it’s pursuing. The analyst believes that Encana could sell its non-core DJ Basin and San Juan assets for US$1.4-1.6 billion as well as its Haynesville natural gas assets for US$1 billion. In completing these sales the company would improve its net debt-to-cash flow ratio to about 2 times. Moreover, it would also provide the company with cash that it could reinvest in additional high return liquids wells, or acquire other liquids rich assets, which would further boost its cash flow.
Investor takeaway
Unlike most of its peers, Encana really doesn’t need meaningfully higher oil prices to deliver stronger returns for its investors. That’s because most of the company’s production is still natural gas, so any incremental liquids output really moves the needle because oil still carries higher margins.
Further, Encana has catalysts from asset sales that could really help to boost its value as the company could pay off a significant amount of debt, giving it one of the best balance sheets in the sector. Add it all up and it’s easy to see why the stock could very well be worth US$18 a share.
