It’s been a rough 18 months for Encana Corporation (TSX:ECA)(NYSE:ECA). Over that period the stock has lost over 70% of its value, management has lowered the dividend multiple times, and the company has reshuffled its finances into survival mode. Investors are clearly still unsatisfied. In the latest three months alone shares are down 25%.
Why should you be interested in a stock that’s been thrown in the market garbage bin?
The drubbing might be overdone
Investors have been relentless in punishing Encana stock. While its future may not exactly be bright, there is still considerable value left in the business. At the current price there may not be much risk left, but investors get a leveraged bet on any oil rebound.
While the market is acting like Encana is poised for bankruptcy, management has done a terrific job positioning the business to remain financially solvent. Spending in 2016 is already completely funded through expected cash flows and existing credit facilities. The company also has focused on paying down some of its debt to maintain its investment grade credit rating. No further debt matures until 2019, giving Encana a few years of breathing room.
To adapt to the low-oil-price environment, management has cut corporate costs by 30% since 2013. It also expects to reduce capital spending this year by $600 million, while still boosting production efficiency by 10-15%. Continued cuts and efficiency gains should help boost next year’s cash flow by over 10%, a critical level to maintain solvency. According to Encana, it should be able to survive the current downturn and benefit once prices start to rise.
What could go wrong?
You may be tempted to bottom-pick Encana’s stock, but there are still some significant risks to any investment. Management would like you to believe that their plans ensure reliable financial stability. In reality, many of their projections rely on $50 a barrel oil. Analysts at Moody’s have recently lowered their 2016 WTI oil-price assumption to just $40 a barrel. If this comes to pass, Encana’s stability would be greatly threatened.
Should you buy or pass?
At this point, it looks like the market is undervaluing Encana shares if oil spends the majority of 2016 at or above $50 a barrel. If oil remains depressed at sub-$40, bottom pickers may end up overpaying big time. While bankruptcy isn’t certain, Encana will have to get creative to remain financially viable. Shares look cheap, but an investment looks to hinge on a single factor: will oil average over $50 a barrel this year? That’s a tough proposition.