Sustainable Investing

Kirk Spano

"World's Next Great Investing Columnist" --MarketWatch

Encana: One of My Dirty Dozen Oil Stocks for 2019

Over the past 25 years I have become known as an oil analyst, including at MarketWatch of the Wall Street Journal network. The transition to sustainable investing is one that will take investors time. In the meantime, there will still be trades available for those interested in fossil fuels. While I normally will post under sustainable investing, here is a piece for the commodities threads.

Most of the trades long-term will be to short fossil fuels. However, in the short-term and possible intermediate term there will be long trades available in oil and natural gas. 

Here is one of the oil stocks that took a beating in Q4 2018. I think it is poised to double or triple in the next 18-30 months. Here is one of my dirty dozen oil stocks for 2019...

Encana

Encana (ECA), post merger with Newfield Exploration (NFX), is one of the largest producers of unconventional oil, natural gas, and NGLs in North America. The company operates three segments:

  1. Canadian Operations - includes Montney and Duverney

  2. USA Operations - includes Eagle Ford, Permian Basin, Williston, Uinta, STACK/SCOOP Anadarko, and Arkoma.

  3. Market Optimization - handles the sale of the company’s proprietary production and the associated netback price.

The combined company will produce approximately 577,000 boe/d. This is about 53% higher production than what Encana was producing as of the end of Q3 2018. The addition of Newfield will turn Encana from a $6.7 billion mid-cap company into a large cap company of over $10 billion.

Source: Encana January 2019 Presentation

Strengths

  • Encana has a strong strategy called “One, Agile, and Driven”. This means that the company strives to be flexible, responsive, and determined/motivated with a commitment to excellence and passion to succeed. This strategy keeps a focus on achieving strong results, which is evident in the company’s efforts for growth.

  • Operations in three top North American plays: Permian, STACK/SCOOP in the Anadarko, and Montney. Encana has geographic diversity within North America. Encana operates in the most productive energy plays. 

  • Encana maintains more total assets than total liabilities for shareholders’ equity of $6.5 billion. This gives the company financial flexability.

  • The company operates and produces out of cash flow.

  • Shareholder yield is high relative to the industry as it is reducing debt, buying back shares and increasing its dividend. 

  • Are planning to return more capital to shareholders via buybacks and dividends.

Weaknesses

  • Encana had negative ROE and ROIC for the past twelve months. This could be temporary due to the dramatic Q4 drop in oil prices in 2018 - ROE and ROIC were 13% and 9% respectively in 2017. Encana has room for improvement for these profitability metrics. 

  • Current ratio is below one - current liabilities are higher than current assets. However, this does occur with capital intensive businesses.

  • Heavily reliant on the price of oil. Encana’s performance can be negatively affected during oil bear markets.

Opportunities

  • Effectively integrate the Newfield operations for overall improvements in returns (ROE, ROIC, etc.) and higher cash flow.  Newfield could help the company improve these metrics going forward as they achieved ROE of 33% and ROIC of 15% TTM. 

  • Continue to expand in the most productive energy plays. This could include future acquisitions for the right companies that operate in the best areas.

  • Dial up production in the Permian Basin as new pipelines come online over the next few years. Increased takeaway capacity will allow Encana to ramp up production.

  • Exploit Canadian natural gas if/when the natural gas market firms.
  • Sell-off non-core assets when timely to provide cash to the bottom line.
  • Diversify into renewable energy when it becomes profitable. This could include solar and wind projects. This would allow the company to evolve as energy trends shift.

  • The company is a potential buyout target. Royal Dutch Shell recently described desirable assets for acquisition that Encana's assets largely match.

Threats

  • Encana is highly levered to the price of oil, natural gas, and NGLs. Therefore, the company is at risk for significant declines in the price of these commodities, particularly oill. Lower prices lowers revenue for the commodities that the company produces. Lower revenues lead to lower earnings and less cash flow.

  • Competition could create oversupply conditions in the market for oil, natural gas, and NGLs. An oversupply typically leads to price declines. The company depends on the decisions made by OPEC to agree on production levels that maintain a supply/demand balance.

  • The company is at risk for divestment from large institutional investors who are moving away from oil and gas investments due to environmental pressures.

  • Environmental policies created by the government could lead to increased costs and taxes as actions are taken to mitigate climate change.

Long-term Investment Outlook

Encana is navigating well in their field. They are striving to operate in the most productive areas. The Newfield deal is likely to significantly strengthen Encana since it adds to the company’s strong energy plays.

The supply/demand dynamics for the oil market have to be watched closely since the company is highly levered to the price of oil.

Buying points for the stock are found after the price of oil drops and a catalyst is created to improve the supply/demand balance.

Selling points for the stock occur when an oversupply condition is inevitable for the price of oil. 

Overall, Encana is positioned well for strong growth during oil bull markets. However, we may be in the last or second-to-last bull market in oil. Investors should consider Encana and all oil stocks as trades that could last a few years, but are not buy and hold forever types.

Kirk Spano covers Sustainable Investing as one of the original contributing analysts at FATRADER. Named the "Next Great Investing Columnist" at MarketWatch, Kirk has been getting the jump on secular trends for over 20 years, and now sees investing in alternative energy, smart grid, EVs, agriculture, healthcare and water as the most likely place to make outsize profits in coming decades.
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