Now that the bear market in energy has stretched out to nearly a year, many investors in the space are beginning to lose patience.
Coupled with the recent weakness in crude, shares of many of Canada’s largest energy producers have been hitting fresh lows, with many companies hitting levels not witnessed since the financial crisis of 2009. Additionally, many pundits are calling for much lower crude prices in the future as Iran looks poised to ramp up production.
This has also affected the natural gas market. Since natural gas is a by-product of the fracking process, the price of the commodity has been depressed as all that new oil supply has come on the market. And as producers continue to desperately squeeze every last drop of crude out of currently producing oil wells, that’s keeping the price of natural gas low.
This has caused a great deal of pain for Encana Corporation (TSX:ECA)(NYSE:ECA). Not only is the company suffering from natural gas’s prolonged weakness, but it also got back into the crude business at precisely the wrong time when it snapped up two huge acquisitions of operations in the United States in 2014. As a result, shares have fallen more than 50% over the past year.
But as the expression goes, it’s often darkest right before the dawn. Here are two reasons why I think there’s potential for the company to turn things around, leading to nice profits for investors who get in now.
The gas market
Natural gas is quickly becoming the choice fuel for many of North America’s power plants.
There are many reasons why. Coal-fired plants can be pretty easily converted to gas, which is really beginning to happen in a big way. Gas is cleaner than coal, and is about the same price even after the price of coal has sold off significantly. Additionally, local and state governments are encouraging coal-fired operators to make the switch.
This all seems like a good idea now, while natural gas is plentiful and cheap. But what about in the future, when some of this new-found supply dries up? If there’s one thing I’ve learned in business, it’s that trends don’t continue forever. At some point, something will happen again and the price of gas will recover. Encana is well positioned to do very well when that happens.
A solid balance sheet
One thing I always look for when investing in a turnaround is the strength of the balance sheet. If a company is drowning in debt, it’s hard to endure many losses.
Encana recently raised some $1.4 billion by selling approximately 100 million new shares. This cash was quickly put to use retiring more than $1.3 billion worth of debt that was set to mature in 2017 and 2018. This leaves the company with no debt due until 2019, when it’ll have $500 million to repay. Four years should be ample time for the underlying commodities to recover. Much of the remaining debt doesn’t come due until at least 2030.
Although I like to see debt-free balance sheets in a turnaround, most energy producers will not give investors that luxury. I’d rate Encana’s balance sheet as pretty good, which is about as good as you’ll get when betting on a turnaround in the sector.
There’s little doubt we could see continued weakness in the energy market over the next weeks and months. But over the long term I’m confident that the market will recover. And thanks to investments made now when times are tough, Encana looks to be one of the winners when the sector recovers. I think patient investors who get in now will be very happy in a few years.
