On September 20 Encana Corporation (TSX:ECA)(NYSE:ECA) agreed to sell 107,000,000 shares at a public offering price of US$9.35 per share, generating a total inflow of more than US$1 billion. Underwriters have an option to sell an additional 16,050,000 shares, which would result in another US$150 million cash inflow.
The stock was down 6% on the news, mainly because the size of the deal forced it to sell shares at a discount.
With a market cap of just US$8.3 billion, the share issuance is huge. What does Encana plan on doing with its new capital hoard?
Half will fund capital expenditures
According to the company itself, “Encana intends to use approximately half of the net proceeds received from the sale of the shares to fund a portion of its 2017 capital program.”
As with 2016, the 2017 capital program is focused on only a handful of properties with the highest-quality reserves and the lower production costs. Already, 96% of Encana’s capital expenditures are dedicated to its four core properties: the Permian, Eagle Ford, Duvernay, and Montney basins. In the second quarter a record-high 73% of production came from these four regions.
Focusing on just a few regions has some major advantages.
First, Encana is able to focus its spending to lower costs in an already low-cost region. In the Permian Basin, for example, Encana has pushed down drilling and completion costs by 31% from 2015 levels.
The second advantage of focusing on these four basins is that they have relatively high levels of oil. Compared to natural gas, oil typically comes with better profit margins along with a significantly improved supply/demand outlook.
Higher capital expenditures in its core properties will result in oil boosting its share of Encana’s output mix. By 2018 natural gas will likely comprise less than 50% of production–down from 82% in 2014.
Other half will pay down debt
According to Encana, “The remaining proceeds will be used to enhance Encana’s balance sheet flexibility by repaying indebtedness under its credit facilities.”
Over the last 18 months Encana sold over $3 billion in assets to help repay $2 billion in debt. With $7.3 billion in debt left, however, the company still has a way to go.
That debt is currently costing it $75 million in interest per quarter. That’s quite a bit lower than its 2012 peak, but further reducing the load would give it improved financial flexibility.
Sunny days ahead?
Encana remains in a tough transition period. But despite shares falling on the day of the announcement, the share issuance should be met with optimism. With the new funds, management can continue to lower its long-term cost base, boost oil production, and grow effectively as commodity prices improve.
If energy prices continue to rebound, expect Encana to continue following suit.
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Fool contributor Ryan Vanzo has no position in any stocks mentioned.