We are maintaining our Neutral recommendation for EnCana Corporation (ECA).
The company’s extensive portfolio of quality natural gas assets spread over Canada and the U.S remains somewhat tempered by its sensitivity to gas price fluctuations, compared to its more diversified independent peers with higher oil production.
EnCana is the second largest gas producer in North America, holding a highly competitive land and resource position in a number of the region’s most promising shale and tight gas resource plays. Its diverse portfolio of natural gas assets over Canada and the U.S. provides a huge inventory of reserves and a resource base that are capable of robust production growth.
We like the company’s dynamic hedging policy, competitive cost structure and strong balance sheet. EnCana has hedged approximately 50% of the expected 2011 natural gas production for the remaining nine months of 2011 at attractive prices, which lowers its near-term commodity-price exposure and brings certainty to future cash flow generation.
Moreover, the company’s strong balance sheet with a debt-to-capitalization ratio of 32.2% as of the first quarter of 2011 and disciplined approach to capital investment have been real assets. These have also benefited the company in generating substantial cash flow ($4.4 billion for 2010) and paying a stable dividend to shareholders.
However, the current unfavorable macro backdrop of weak natural gas prices remains our concern. EnCana’s extensive natural gas exposure raises its sensitivity to gas price fluctuations, compared to its more diversified independent peers with higher oil production. The company, which derives almost all of its reserves/production from natural gas, has seen its sales and income fall drastically in recent quarters on the back of a sharp drop in gas prices.
Recently, EnCana revealed that it has ended discussions with Chinese energy giant PetroChina Co. Ltd. (PTR) without reaching an agreement on the key aspects of the deal. The potential transaction regarding the sale of half of its prolific Cutbank Ridge shale natural gas assets in British Columbia and Alberta for approximately C$5.4 billion (U.S. $5.4 billion), was expected to close in the middle of this year.
The deal would have enabled EnCana to accelerate output while containing development expenditures at one of its core properties, thereby coping with the weak North American natural gas environment. The proceeds were supposed to help the company to support its balance sheet, fund an ambitious capital expenditure program and pay down debt.
EnCana shares currently retain a Zacks #3 Rank, which translates into a short-term Hold rating.
