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Is Encana Corp (TSX:ECA) Stock Really That Cheap?

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On many metrics, Encana (TSX:ECA)(NYSE:ECA) stock appears cheap. Shares trade at less than seven times earnings and just five times EV to EBITDA.

Compared to many of its peers, Encana stock really is cheap. Cenovus Energy, for example, posted a cumulative loss in 2018. Still, it trades at 7.4 times EV to EBITDA.

While Encana is cheap compared to its peer group, is it cheap for a reason? Let’s find out.

Encana thinks it’s underpriced

For its part, Encana has been betting that its shares are cheap. In February, the dividend was boosted by 25%. In March, management instituted a $1.25 billion share buyback, roughly 10% of the entire company.

The company plans to be aggressive over the next 12 months as well.

Company executives plan to finish the stock buyback in 2019 and will consider another program depending on prevailing conditions. They have also reiterated that they remain committed to the current dividend and will also revisit an additional boost pending approval from its board.

Free cash flow makes it all possible

While many companies believe their shares to be cheap, not all can take advantage. The actions above are only made possible by Encana’s newfound free cash flow.

After losing more than $5 billion in 2015, not to mention a $1 billion loss in 2016, Encana went into survival mode. Management scrambled to cut costs, rationalize drilling, and shore up its balance sheet. By all accounts, these emergency measures were a success.

In 2013, long-term debt stood at $7.1 billion. Today, it’s down to $4.2 billion, earning a credit-rating upgrade in February from Fitch. This debt reduction lowered annual interest expenses by roughly $200 million — a huge savings for a cash-starved business.

These moves helped generate more than $600 million in free cash flow last year. This year, management expects to remain free cash flow positive.

Shares actually are cheap

While shares continue to trade at 2004 prices, Encana is far from survival mode.

The company currently has $1.3 billion in cash, $4 billion in credit lines, and only $500 million in debt maturities over the next 24 months. If Encana can stay free cash flow positive, expect the company to implement yet another sizable share-buyback program.

This year, total costs should come in around $13 per barrel — a $0.50 reduction versus 2018. Selling prices, meanwhile, have the potential to rise.

In April, the U.S. revealed it would retract sanction exemptions for countries purchasing Iranian oil. Already, oil prices have surged by nearly 50% year to date. While the market waits to see what happens politically, there’s a chance the entire market can be upended.

Encana’s management team believes it can remain free cash flow positive with a “low to mid $50-per-barrel WTI oil price.” At current trading prices, it should have no problem achieving that.

If political tensions ramp, Encana could easily generate more than $1 billion in free cash flow this year. If this happens, expect management to buy back stock at a quick pace.

As mentioned, oil prices are up nearly 50% year to date. Encana shares, meanwhile, have only increased by 25%.

With a low-cost position and reduced debt load, Encana can weather another downturn in energy prices. If selling prices improve, however, it’s tough to argue that shares aren’t undervalued.

In a troubled Canadian energy sector, Encana looks like a diamond in the rough.

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

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