Energy Investors: Encana Corporation or Enerplus Corp.?

Both Encana Corporation (TSX:ECA)(NYSE:ECA) and Enerplus Corp. (TSX:ERF)(NYSE:ERF) are taking on long-term transformations.

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Over the past five years, Encana Corporation (TSX:ECA)(NYSE:ECA) and Enerplus Corp. (TSX:ERF)(NYSE:ERF) shares have dropped even further than historically low natural gas prices. The companies’ stocks have fallen over 70% in that time period, despite strong rallies in recent months.

Both firms remain highly leveraged to natural gas prices. Encana’s production is roughly 75% natural gas and 25% crude oil. Enerplus’s properties consist of approximately 42% crude oil and natural gas liquids and 58% natural gas properties. Despite their current exposure, however, Encana and Enerplus are making strides in moving away from natural gas, potentially making them great picks for long-term investors willing to persevere through the transition process.

Which stock is better for patient energy investors?


Encana is on the verge of transformation

While natural gas still constitutes over 75% of Encana’s output, oil has grown from 5% of production to nearly 20% in just a few years. The company’s management team hopes that oil will become the major driver of future profits. To complete its transition towards oil, Encana has focused capital spending on just four primary projects that are rich in oil. Assets sales—of which it has at least $1 billion planned—will also aid in the transition as they will likely target natural gas properties for divestment.

The shift away from natural gas makes sense. This past quarter the company realized unhedged gas prices of $1.73 per thousand cubic feet. Encana’s projects only generate adequate returns at around $3 per thousand cubic feet. Its major oil projects, meanwhile, are projected to have 30% returns at $50 oil. Oil is only 15% away from this target, while natural gas prices would need to nearly double.

The transition towards oil production should take years, but shares will likely receive a higher valuation premium every quarter Encana can limit its natural gas exposure.

Enerplus is further along

In its transition towards oil, Enerplus is a bit ahead of Encana. This year, the company estimates that every $5 increase in crude prices adds $66 million to cash flows. A $5-per-barrel increase would only represent a 15% pop in oil prices. A natural gas rally would be much less helpful. For every $0.50 per mcf increase in natural gas prices (a 30% rise from today’s levels), cash flows would only increase by $44 million. For 2016, Enerplus has a $200 million drilling program that is focused on boosting oil production.

Because its capital spending is funded completely by internal cash flows based on $39 a barrel, the company will continue to move away from natural gas without incurring additional debt. In coming years, Enerplus should move based on swings in oil, not natural gas.

Which should you choose?

While Enerplus is further along in its transition towards a more profitable commodity, the market has already priced in a valuation premium for the company. Enerplus shares now trade at 1.4 times book value, versus just 0.8 times for Encana. During 2014 and 2015, the companies traded at roughly the same valuation. With historically weak natural gas prices, it looks like the market is preferring Enerplus’s oil exposure.

If you’re in for the long term, however, Encana should warrant a higher valuation premium as it completes its transition towards oil. A higher multiple could add significant value to shares if you’re patient enough to ride out the transition.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Ryan Vanzo has no position in any stocks mentioned.

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