Encana Corporation (TSX:ECA)(NYSE:ECA) just reminded investors that the energy rout is far from over.
More cuts
Encana is reducing its dividend again and has cut the 2016 capital program by another 25%.
The company says it now plans to spend US$1.5-1.7 billion next year, down from US$2.2 billion in 2015. About 95% of the spending in 2016 will be focused on four core assets with 50% of the funds headed to the operations in the Permian play.
Production levels are going to take a hit as a result, with 2016 output now targeted at 340,000-370,000 boe/d, down from the 2015 guidance of 395,000-430,000 boe/d.
The ongoing woes in the oil and natural gas markets have taken all the steam out of the latest rally in Encana’s stock, which had surged from below $8 per share in late August to above $11 per share at the beginning of December.
The news of the latest cuts and reduced output guidance has pushed the stock back below the $8 level, and investors are wondering if this is the beginning of the end.
Balance sheet stability
Encana loaded up its balance sheet with debt when it made a couple of expensive oil acquisitions just before crude prices began their swan dive last year. At the beginning of 2015, the long-term debt position sat at US$7.8 billion.
Management has been in survival mode ever since, unloading natural gas assets, raising capital, and slashing expenditures in an effort to remain solvent.
Given the circumstance, they are doing a pretty good job. Corporate expenses are down US$300 million and the company found buyers for $1.44 billion in new stock earlier this year at $14.60 per share. Encana has also sold US$2.8 billion in assets and plans to reduce the total debt level by that amount by the end of 2015. None of the long-term debt is due before 2019.
Cash flow concerns
Encana had Q3 cash flow from operations of US$371 million and spent US$473 million on capital expenditures, so there was a shortfall of US$102 million in the quarter, and that was before the company paid out US$38 million in dividends.
The new reduction in both the capex program and the dividend will help alleviate the shortage, but oil and natural gas prices are plummeting to new lows, and the reduced output is going to mean lower revenues.
In the December 14th news release Encana says its new 2016 capital targets assume an average WTI oil price of US$50 per barrel and a NYMEX natural gas price of US$2.75 per MMBtu. Based on these assumptions, 2016 cash flow is expected to be US$1-1.2 billion.
WTI oil is currently trading at US$35 per barrel and natural gas is US$1.90 per MMBtu. Those prices are significantly below the company’s targets for 2016.
Will Encana survive?
The company has some hedging in place to help support cash flow and enough room in its credit lines to limp along for a while longer, but energy prices have to rebound significantly if the business is going make it through the rout.
Encana owns fantastic assets, and the end game in 2016 could be a buyout by one of the larger oil companies. Assuming a US$5 billion debt position and the current market cap of US$5 billion, one of the majors could now take out Encana for US$10 billion plus a premium. That’s not small change, and it is certainly possible.
Should you buy?
If you think oil and natural gas are at the bottom of cycle, Encana has a lot of upside potential, but that’s a risky bet to make right now and there are safer ways to play a rebound in the energy sector.
