The recent oil recovery is holding up better than expected, and this is bringing investors back into the energy space.
Let’s take a look at Encana Corporation (TSX:ECA)(NYSE:ECA) to see if the latest rally in the stock could have legs.
Tough times
Encana has more than doubled in the past two months, but the move from $3 per share to just shy of the $8 mark is little consolation for long-time investors.
Five years ago Encana traded for $30 per share. The plunge in oil over the past two years is responsible for much of the pain, but ill-timed transitions are also to blame.
In the wake of the financial crisis, Encana decided to focus on being a natural gas company and spun off the oil and refining assets into a new business called Cenovus Energy.
Shortly after the creation of Cenovus, oil prices rallied on strong global demand and natural gas prices tanked as the North American shale boom flooded the market with supply.
As WTI oil traded above US$100 per barrel, Encana switched directions, again, and began buying oil properties. This decision saddled the firm with a massive debt just as oil hit its peak.
As a result, Encana has spent most of the past two years trying to stay alive.
The upside opportunity
Management has done a good job of unloading assets, reducing admin costs, and lowering operating expenses.
The debt load at the end of 2015 was down to US$4.7 billion and none of the obligations are due before 2019. This is buying the company time as it waits for a broader oil recovery.
Capital outlays have also been reduced to less than US$1 billion for 2016. Encana is focusing 95% of its capital program on the four core assets located in the Permian, Montney, Duvernay, and Eagle Ford plays, which are low-cost sites.
The company has hedged 75% of its oil and gas production from March to December of this year. That move should ensure Encana remains capable of meeting its cash flow obligations in the event the latest run up in oil is another head fake before a return to the January lows.
Could the stock continue to rally?
Everything depends on energy prices, and a move to $20 would require another big surge in oil, but Encana has significant upside potential if prices continue to recover.
A takeover is also worth considering.
Encana is sitting on roughly 290 million barrels of oil and NGL reserves, as well as more than three trillion cubic feet of natural gas reserves. If the energy sector is truly on the mend, Encana could become a takeout target.
