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Encana Corporation Takes Another Step in the Right Direction

Last week Encana Corporation (TSX:ECA)(NYSE:ECA) announced that it was selling its Haynesville natural gas assets to a private buyer for US$850 million. It’s a move that will not only bring cash in the door initially, but will reduce gathering and midstream outflows of US$480 million through 2020 as well as bring in additional cash inflows from a fee-for-service gas marketing agreement over the next five years.

However, just as important is the fact that the deal is another step towards improving the company’s per barrel margins, which will be much higher in the future as it continues to focus on oil.

Details on the deal

Encana’s Haynesville natural gas asset consists of 112,000 net acres in northern Louisiana plus fee mineral lands. To date, the company has drilled more than 300 wells on its acreage, and those wells produced an average of 217 mmcf/d, which represented about 9% of the company’s daily production.

Further, the acreage position was estimated to hold 720 bcfe of natural gas reserves. Initially, the company plans to use the proceeds from the sale to reduce its debt. That will not only bolster its balance sheet, but reduce interest expenses. This increased financial flexibility is really critical during a downturn like the one the industry is going through.

The real motive

However, while the balance sheet improvement is nice, that’s not Encana’s real motive in jettisoning its Haynesville gas assets. Instead, the move is all about improving its margins. That’s clear when looking at the margins of Haynesville versus the company’s four core plays of the Eagle Ford, Permian Basin, Montney, and Duvernay. While the Haynesville shale represented 9% of the company’s daily production, it was only contributing 2.5% of the company’s cash flow.

On the other hand, the operating margins from its more oil-weighted assets—the Permian, Eagle Ford, and Duvernay—deliver roughly 50% margins at a $50 oil prices, while even the more gas-weighted Montney’s margins are about a third at a $3 gas price. So, by selling the very low margin Haynesville asset, Encana will boost its overall margins per barrel of oil equivalent.

Encana has really focused its attention on growing its higher margin production so that it can improve its company-wide per barrel margin. The biggest driver of this plan is the company’s decision to invest 80% of its 2015 capital budget into its four higher margin core plays. By improving its margins, Encana will not only generate solid cash flow when prices are weak, but really position the company cash in when prices eventually improve.

Investor takeaway

Encana has really become a more margin-focused company over the past few years. The company has taken a two-pronged approach by selling its lower margin assets and investing to grow higher margin production. It’s a plan that is bolstering the company’s cash-generating ability during the weak times so that it is in a position to really thrive when conditions improve.

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Fool contributor Matt DiLallo has no position in any stocks mentioned.

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