ENCANA CORP. $22 (Toronto symbol ECA; Conservative Growth Portfolio, Resources sector; Shares outstanding: 736.3 million; Market cap: $16.2 billion; Price-to-sales ratio: 2.5; Dividend yield: 3.6%; TSINetwork Rating: Average; www.encana.com) is one of North America’s largest natural gas producers. The U.S. accounts for 55% of Encana’s production, while Canada supplies the remaining 45%. The company’s proven reserves should last over 14 years. If you include properties where estimates are less well defined, Encana’s reserves could last 50 years.

On December 1, 2009, the old EnCana Corp. split itself into two new companies: the new Encana and Cenovus Energy Toronto symbol CVE), which specializes in oil sands projects, oil refineries and conventional natural gas. The new Encana’s revenue fell 4.5%, from $8.9 billion in 2010 to $8.5 billion in 2011 (all amounts except share price and market cap in U.S. dollars). New techniques, such as horizontal drilling, have unlocked large amounts of shale gas. This has increased inventories and cut gas prices: the company sold its gas for $4.96 per thousand cubic feet in 2011, down 9.5% from $5.48 in 2010.

Earnings fell 33.3%, to $0.54 a share (or a total of $398 million) from $0.81 (or $598 million). Cash flow per share fell 5.4%, to $5.66 from $5.98.

Gas prices have moved up lately, but they are still well below their 2011 levels. Encana has shut down some of its wells in response.

As a result, its earnings fell 32.1% in the quarter ended September 30, 2012, to $0.36 a share (or a total of $263 million). A year earlier, it earned $0.53 a share (or $389 million). Cash flow per share fell 22.5%, to $1.24 from $1.60. Revenue dropped 56.4%, to $1.0 billion from $2.4 billion.

Hedges help cut risk

The average market price for gas fell 33.1% in the quarter, to $2.81 per thousand cubic feet from $4.20 a year earlier. However, Encana locks in prices for much of its production. Thanks to these hedges, Encana’s realized gas price fell just 2.0%, to $4.91 from $5.01.

The company continues to expand its hedging program. It has now locked in prices for 39% of its projected 2013 production at $4.51 per thousand cubic feet, well above today’s price of $3.71.

Encana is also increasing production of higher priced natural gas liquids (NGLs), such as ethane, propane and butane. NGL production, including oil, rose 24.2% in the latest quarter, to 30,300 barrels a day from 24,400 barrels a year earlier. The company aims to produce between 60,000 and 70,000 barrels of oil and NGLs a day in 2013. Encana will probably spend $3.5 billion on capital projects, including increasing its NGL production, in 2012. That’s almost equal to its projected cash flow of $3.6 billion. However, Encana is offsetting the costs of these projects by selling some of its less important properties. Low gas prices may limit interest from potential buyers, so the company will probably divide some of these assets into smaller pieces to attract a wider range of bidders.

Joint ventures lower Encana’s costs

The company is also forming joint ventures to offset its capital costs. In all, it feels these moves will result in $3 billion of new funding in 2012. Encana aims to bring in an additional $1.0 billion to $1.5 billion in 2013.

Encana’s spending plans do not include its 30% stake in a proposed liquefied natural gas (LNG) terminal at Kitimat, B.C. Pipelines will pump natural gas from western Canada to the Kitimat terminal, which will convert the gas into a liquid. From there, tankers will ship it to Asian markets.

Apache Corp. (New York symbol APA) owns 40% of the Kitimat project, and will operate it; EOG Resources Canada Inc. owns the other 30%. The company’s share of the terminal’s construction costs would be around $1.3 billion. The partners are still evaluating the project, and should make a final decision in the next few months.

The company’s balance sheet remains sound. Its long-term debt of $7.7 billion is a high, but manageable, 48% of its market cap. It also holds cash of $2.0 billion, or $2.77 a share.

Focus on cash flow instead of earnings

The stock trades at 16.7 times Encana’s forecast 2012 earnings of $1.31 a share. However, accounting rules force oil and gas producers to earmark funds for depletion (the cost of replenishing their reserves). If a company is exploiting a rich deposit, high depletion charges will depress its earnings and inflate its p/e ratio. Encana’s likely 2012 cash flow, which excludes depletion and other non-cash items, is $4.93 a share. The stock trades at a more appealing 4.4 times that estimate.

The company’s cash flow, as well as proceeds from planned asset sales, should let it keep paying quarterly dividends of $0.20 a share, for a 3.6% annualized yield.

Encana is a buy.