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S&P Capital IQ


02/13/17 10:00:08 AM



This week's Focus Stock of the Week is Encana Corporation (ECA: $13) which carries S&P Capital IQ's highest investment recommendation of 5-STARS, or Strong Buy. Encana is a leading North American producer of oil, natural gas, and natural gas liquids (NGLs). ECA has effectively undertaken a major portfolio transformation, shifting from a predominantly natural gas producer to a more balanced portfolio, with a focus on growing liquids: both oil and NGLs.

Our Strong Buy recommendation reflects our view that Encana has an improved balance sheet and is entering a production and cash flow growth phase. We think ECA has some of the highest-quality assets in North America and we see a strong management team driving net asset value (NAV) per-share growth. Although ECA has faced weak oil and natural gas prices (which led to high levels of debt and necessary dividend cuts), we think this overhang on the stock has been lifted. Encana now has strong liquidity and an improved balance sheet; the company is poised to deliver strong production and cash flow growth going forward.

Encana has four core assets, resource basins where ECA is spending the majority of its capital. These include: 1.) Permian: stacked resource potential located in the heart of the oil-rich Midland basis in Texas. 2.) Eagle Ford: an oil-weighted top-tier asset in Texas. 3.) Duvernay: ECA has a premier position in this emerging condensate-rich play in central Alberta. 4.) Montney: stacked resource potential with extensive liquids and gas optionality in northeast British Columbia and northwest Alberta.

One of the most attractive aspects of ECA's stock, in our opinion, is a clear strategic focus on its core resource plays; 95% of 2017 capital is to be spent in these basins, assets that offer top-tier economic returns. Encana has proven to be a top-tier operator in all four plays. Within its core acreage, ECA has over 20,000 total inventory locations (i.e. future wells), 10,000 of which ECA calls premium return locations with greater than 35% after-tax rate of return, assuming WTI oil trades at a flat $50 per barrel (bbl) and NYMEX natural gas trades at $3 per million British thermal units (MMBtu).

In Encana's five-year plan through 2021 (which assumes flat $55/bbl WTI and $3/MMBtu NYMEX), the company plans to growth production by greater than 60% (including a 15-20% compound annual growth rate [CAGR] in liquids, double its corporate margin from $8 per barrel of oil equivalent (BOE) to $16/BOE, grow its cash flow by more than 300%, while consuming only 15% of its 10,000 premium drilling locations.

Encana plans to direct 50% of its capital into the Permian basin over the next five years, where we think production will growth at a five-year CAGR of over 30%. ECA has lowered its drilling and completion (D&C) costs in the Permian by 40% over a six-quarter period (as of the third quarter of 2016); we think ECA's current D&C costs are setting the bar for capital efficiency in the Midland basin.

Encana's management team has done a great job improving the balance sheet; total debt has been reduced by $3.1 billion since year-end 2014. ECA now has significant financial flexibility with no debt maturities until 2019 (75% of fixed rate long-term debt is not due until 2030 and beyond). ECA has an unutilized $4.5 billion fully committed, unsecured revolving credit facility. We also note a strong hedge portfolio in 2017 offers greater cash flow certainty, reducing the capital program execution risk. We think ECA's capital program will be self-funding starting in 2018.

Our 12-month target price of $18 reflects an EV/EBITDA multiple of 7.5X our 2018 EBITDA estimate, a small premium to ECA's three-year average forward EV/EBITDA multiple of 7.3X, but a discount to its peers' average forward EV/EBITDA multiple of 9.2X. We think our valuation fairly accounts for top-tier assets and production growth, partly offset by the relatively higher levels of debt currently. We think ECA's transformation and self-help efforts have positioned the company to greatly benefit from a new period of growth.

Risks to our recommendation and target price include renewed weakness in crude prices, unplanned downtime at producing facilities, unexpected pipeline outages, and unfavorable regulations concerning royalties or taxes.

S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.


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