ENCANA CORP. $30 (Toronto symbol ECA; Conservative Growth Portfolio, Resources sector; Shares outstanding: 736.2 million; Market cap: $22.1 billion; Price-to-sales ratio: 1.8; Dividend yield: 2.8%; SI Rating: Average) is one of North America’s largest natural-gas producers.
The company prefers to focus on large unconventional reserves, including shale gas, which is natural gas that is trapped in rock formations. To extract it, companies must pump water and chemicals into the rock. This fractures the rock and releases the natural gas. At current production rates, Encana’s proved reserves should last 12 years. However, these properties could last 50 years if you include harder-to-reach reserves.
Despite weak gas prices, Encana plans to double its gas production over the next five years. That would help raise its market share, because low gas prices have prompted many of its competitors to cut production.
To achieve this goal, Encana plans to spend $5 billion on drilling and other capital projects in 2010 (all amounts except share price and market cap in U.S. dollars). That’s $500 million more than its earlier forecast.
Hedging works both ways
Encana uses hedging contracts to lock in selling prices for its natural gas. Hedging cuts Encana’s risk, but it can also work against the company.
In the three months ended June 30, 2010, Encana reported a hedging loss of $340 million. It also has a $246-million foreign-exchange loss related to its Canadian-dollar-denominated debt.
Even if you exclude these losses, Encana’s earnings still fell 82.8% in the latest quarter, to $81 million, or $0.11 a share, from $472 million, or $0.63 a share, a year earlier. Cash flow per share fell 13.2%, to $1.65 from $1.90. Revenue rose 10.2%, to $1.5 billion from $1.3 billion. (Note: The year-earlier figures assume that the break-up of the old EnCana took place at the start of 2009.)
Lower natural-gas prices were the main reason for the declines in earnings and cash flow. Encana’s average selling price for gas fell 18.6% during the quarter, to $5.74 per thousand cubic feet from $7.05 a year earlier. The price decline offset a 7.9% rise in production.
For the second half of 2010, Encana has locked in prices for 55% of its expected gas production at $6.05 per thousand cubic feet. That’s 58.4% higher than the current spot price of $3.82.
Balance sheet will support growth
Encana’s strong balance sheet will help it keep increasing production. Its long-term debt of $7.6 billion is just 1.6 times its annual cash flow, so it can afford to borrow more funds. Plus, the company holds cash of $1.5 billion, or $2.01 a share.
Encana should earn $1.34 U.S. a share in 2010. It trades at 21.6 times that figure. The shares also trade at 4.8 times its projected cash flow of $6.00 U.S. a share. These are reasonable multiples in light of its low-cost operations and large reserves.
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