Encana Corporation (TSX:ECA)(NYSE:ECA) is up 50% in 2016, and investors who missed the rally are wondering if more upside is on the way.
Let’s take a look at the current situation to see if Encana deserves to be in your portfolio.
Tough times
Investors who had the guts to buy the stock below $5 in February are looking at a 100% gain, but the rally is little consolation for long-term holders of the stock. Five years ago Encana traded for more than $30 per share.
The bloodbath is the result of a series of ill-timed strategy shifts.
In the wake of the financial crisis, management decided to focus on natural gas and spun off the oil sands and refining assets into a new company called Cenovus Energy.
As we all know, oil prices subsequently surged on the back of strong global demand and natural gas prices tanked amid the shale boom in the United States.
A new executive team then took the reins and began to reverse course, betting big on oil properties just as WTI prices peaked above US$100 per barrel. Those acquisitions loaded up the balance sheet with debt, and the result has been a disaster for shareholders.
On the mend
Encana has done a good job of staying alive through the oil rout by selling off non-core assets and lowering capital expenditures. Reduced operating costs have also helped and Encana is now capable of living within its cash flow if WTI trades above US$40 per barrel.
Long-term debt has come down considerably but was still US$5.4 billion at the end of Q1 2016. That’s a lot to carry for a company with a market capitalization of US$7 billion. None of the notes are due before 2019, so Encana still has time to get its house in order, but the clock is ticking.
Selling the crown jewels?
The company is focusing 95% of its capital investments on the four core assets located in the Montney, Duvernay, Eagle Ford, and Permian plays. Until recently, these assets were considered untouchable in the efforts to reduce debt through divestitures.
That just changed.
Encana is selling 54,200 acres of land in the Montney formation for $625 million in cash. The properties are currently producing 26,000 barrels of oil equivalent per day (boe/d).
Management says it is “sharpening” its focus on the Montney play. Investors have to ask themselves if the move is a sign that times are still extremely tough despite the recovery in oil and gas prices. Encana says it will use the funds from the Montney deal to reduce debt and bolster the balance sheet.
Should you buy?
Encana delivered ugly Q1 2016 results, but the Q2 numbers should be better given the rebound in oil prices. The stock still has decent upside potential if oil and gas prices continue to recover, and I think the company could become the target of a takeover bid as consolidation ramps up in the oil patch.
However, the fact that Encana is starting to sell off assets in its “core” holdings is a bit of a concern, and the debt level means Encana remains a risky bet, especially if oil repeats last year’s performance and rolls over in the back half of the year.
You have to be an energy bull to buy the stock today. I would at least wait for the Q2 numbers to come out before deciding whether or not you should start a position in this company.
