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In this article, I will review one of the oldest energy producers in North America. I will discuss its strategy and its most notable operations in Canada and the U.S. Then, I will provide an analysis on the most recent financial data as well as its future outlook. Furthermore, I will offer my thesis on Encana to explain why the company is one of my favorite natural gas producer in the industry.

Encana Corporation (NYSE:ECA)

Encana is a leading North American energy producer focused on growing its strong portfolio of diverse resource plays producing natural gas, oil and NGLs (natural gas liquids).

Encana is pursuing the key business objectives of maintaining financial strength, optimizing capital investments in the company's highest return projects, reducing costs and continuing to pay a stable dividend to shareholders.

Encana's extensive portfolio of reserves and contingent resources in diverse resource plays serve as the foundation for its long-term strategy of accelerating the value recognition of its assets. The producer has a history of entering prospective plays early and leveraging technology to unlock resources and build the underlying productive capacity at a low cost.

A Long, History-Rich Success

Encana's history touches on some of the most significant political and economic events in Canada and the world in the last 125 years, from the continental migration in the 1880s, the energy crisis of the 1970s, to the emergence of unconventional energy resources at the turn of the 21st century.

Created through the merger of PanCanadian Energy Corporation and Alberta Energy Company in 2002, its predecessor companies' roots go back as far as some of the world's oldest petroleum companies.

A Proven Strategy

The top priority for Encana is to maintain capital discipline and driving down its costs. Its tactics have adapted to the changes in its external environment, most notably with the prolonged decrease in natural gas prices. The company is contemplating a shift to liquids but the transition is carefully measured by the pace of investment and ensuring that the speed of that transition is also measured on results.

Encana plans to maintain its industry leadership in the production of natural gas while preserving financial strength and flexibility. The company is also working to expand the use of natural gas in power generation, transportation and industrial applications.

Encana's resource play hub model, which utilizes highly integrated production facilities, is used to develop resources by drilling multiple wells from central pad sites. Repeatable operations lend themselves to ongoing cost reductions through optimization of equipment and processes by applying continuous improvement techniques.

Source: Encana's Corporate Presentation, August 2013

Its resource play hub model strives to reduce operating and capital costs while continually improving operating efficiencies to maximize the margins realized on every single natural gas molecule produced. Implemented across its entire North American asset portfolio, the resource play hub is an innovative and efficient production model. As a matter of fact, it is tailor-made to reduce natural gas production costs and environmental impacts.

Encana's capital investment strategy is focused on building long-term production growth capacity and transitioning to a more diversified portfolio of production and cash flows. To do so, it plans to grow its exposure to oil and NGLs. That exposure will ensure sustainability in a lower price environment by leveraging technology and expertise. It will also focus the resources on the highest quality opportunities and to maximize margins by controlling costs. Finally, it plans to target 12-36 months to achieve cost structure improvements.

Encana's Portfolio Of Promising High-Quality Resource Plays

The gas producer has amassed a large, concentrated contiguous land position in the core of many of North America's best resource plays, at low-entry costs. At a glance, it owns 10.92 millions in net acres of land with 18,826 net wells that produce an average of 2,800Mmcf/d (million cubic feet per day) of natural gas.

Its operations can be divided in two: the Canadian Division and the U.S. Division.

Canadian Division

Source: Encana's Corporate Presentation, August 2013

The Canadian Division includes the exploration, development and production of natural gas, oil and NGLs, and other related activities throughout Canada, primarily in western Canada.

Source: Encana's Corporate Presentation, August 2013

In 2012, the total capital investment in this division was approximately $1,567 million and Encana drilled approximately 372 net wells. Production after royalties averaged approximately 1,359Mmcf/d of natural gas and approximately 19.4Mbbls/d (thousand barrels per day) of oil and NGLs. At December 31, 2012, the Canadian Division had an established land position in Canada of approximately 10.1 million gross acres (8.0 million net acres), including approximately 5.1 million gross undeveloped acres (4.0 million net acres), which account for 50% of undeveloped land.

Source: Encana's Corporate Presentation, August 2013

The resource plays include assets in British Columbia:

  • Cutbank Ridge, located in the foothills of the Rocky Mountains southwest of Dawson Creek; this asset produces from the Montney, Cadomin and Doig formations.

Production History

Natural Gas (MMcf/d)Oil & NGLs (Mbbls/d)
2012201120122011
4334281.51.1
  • Greater Sierra, including Horn River; the area is located in the northeast corner of the province in the region of Fort Nelson. The production comes from the Jean Marie Formation and the Devonian-aged Horn River Shale.

Production History

Natural Gas (MMcf/d)Oil & NGLs (Mbbls/d)
2012201120122011
2002600.50.8

The resource plays include assets in Alberta:

  • Bighorn, East of Grande Cache in the West Central part of the province, producing from a multi-zone stacked cretaceous sands in the Deep Basin.

Production History

Natural Gas (MMcf/d)Oil & NGLs (Mbbls/d)
2012201120122011
2422305.83.5
  • Peace River Arch, a newer resource play in the northwest of the province in the area of Grande Prairie, focused on the continued development of the Montney Formation.

Production History

Natural Gas (MMcf/d)Oil & NGLs (Mbbls/d)
2012201120122011
1081012.92.1
  • Clearwater, including Clearwater Oil, it extends from the U.S. Border to the central part of the province with local communities that include Calgary, Strathmore, Drumheller and Red Deer. It is focused on the development of Horseshoe Canyon coals, shallower sands and deeper targets using an integrated wellbore strategy.

Production History

Natural Gas (MMcf/d)Oil & NGLs (Mbbls/d)
2012201120122011
3744338.67.0
  • Duvernay, an emerging Canadian resource play located in West Central Alberta. The company entered in December 2012, into an agreement with a subsidiary of PetroChina (PTR) to jointly explore and develop certain Duvernay lands in Alberta. PetroChina agreed to invest approximately $2.18 billion for a 49.9% working interest in the lands.

U.S. Division

Source: Encana's Corporate Presentation, August 2013

The U.S. Division includes the exploration, development and production of natural gas, oil and NGLs, and other related activities within the U.S. In 2012, the division had total capital investment of approximately $1,727 million and drilled approximately 285 net wells.

Source: Encana's Corporate Presentation, August 2013

Production after royalties averaged approximately 1,622Mmcf/d of natural gas and approximately 11.6Mbbls/d of oil and NGLs. At December 31, 2012, it had an established land position of approximately 3.4 million gross acres (2.9 million net acres), including approximately 2.7 million gross undeveloped acres (2.3 million net acres), which account for more than 79% of undeveloped land.

Source: Encana's Corporate Presentation, August 2013

The resource plays include assets in Colorado:

  • Piceance including Niobrara/Mancos; this asset is a resource play in the northwest portion of the state and operates in the William Fork Formation characterized by thick natural gas accumulations.

Production History

Natural Gas (MMcf/d)Oil & NGLs (Mbbls/d)
2012201120122011
4754352.21.9
  • DJ Niobrara, an emerging play in the northeast corner of the state. The liquids play is located in the DJ Basin in northern Colorado with primary formation targeted in the basin with the Codell, J-Sand and the Niobrara.

The resource plays include an asset in Kansas:

  • Mississippian Lime, an emerging resource play in Kansas and the northern portion of Oklahoma that is still being assessed.

The resource plays include assets in Louisiana:

  • Haynesville, this play straddles the Louisiana/Texas Border with the focus on maximizing gas recovery in the Haynesville and Mid-Bossier horizons.

Production History

Natural Gas (MMcf/d)Oil & NGLs (Mbbls/d)
2012201120122011
475508--
  • Tuscaloosa Marine Shale, an emerging resource play that extends across the Border between northeast Louisiana and Mississippi. The property is still being assessed.

The resource plays include an asset in Michigan:

  • Collingwood/Utica Shale, an emerging resource play in the northern part of the state that is still being assessed.

The resource plays include an asset in New Mexico:

  • San Juan; this emerging resource play is located in the northwest corner of the state with the focus on the Gallup and Mancos silt.

The resource plays include an asset in Texas:

  • Texas, including Eaglebine; this resource play has operations primarily located in East Texas. It is focused on tight gas with multi-zone targets in the Bossier and Cotton Valley zones, as well as shale gas in the Haynesville and Mid-Bossier horizons.

Production History

Natural Gas (MMcf/d)Oil & NGLs (Mbbls/d)
2012201120122011
1673760.10.3

The resource plays include an asset in Wyoming:

  • Jonah, a resource play found in southwest Wyoming in the area of Pinedale and Riverton. The production comes from the Lance Formation, which contains vertically stacked sands.

Production History

Natural Gas (MMcf/d)Oil & NGLs (Mbbls/d)
2012201120122011
4114714.14.3

Financial Highlights

Encana reported cash flow of $665 million, a decrease of $129 million for Q2 of 2013, primarily due to lower realized financial hedging gains of $584 million before tax, partially offset by higher realized natural gas prices which increased revenues $445 million. Cash and cash equivalents totaled $2.91 billion for Q2, a substantial increase of 55.6% over the same period last year.

The average realized natural gas prices, excluding financial hedges, were $3.99/Mcf compared to $2.25/Mcf in 2012, reflecting higher benchmark prices. Average natural gas production volumes of 2,766Mmcf/d decreased 36Mmcf/d from 2,802Mmcf/d in 2012. The drop was primarily the result of the company's capital investment focus in oil and liquids-rich natural gas plays and a reduced capital investment program, partially offset by shut-in production volumes in 2012.

The Canadian Division's natural gas volumes were higher primarily due to successful drilling programs at Cutbank Ridge and Greater Sierra and shut-in production volumes in 2012, partially offset by natural declines. The U.S. Division's volumes were lower primarily due to natural declines, partially offset by shut-in production volumes in 2012.

The producer's average natural gas production volumes in Q2 and the first six months of 2013 were impacted by the company's capital investment focus in oil and liquids-rich natural gas plays and a reduced capital investment program, partially offset by shut-in production volumes in 2012.

Encana's average realized oil price for Q2 and the first six months of 2013 generally reflected higher benchmark prices. Hedging activities contributed an additional $2.38/Bbl to the average realized oil price in Q2 of 2013 and an additional $3.71/Bbl in the first six months of 2013. The average oil and NGL production volumes of 47.6Mbbls/d increased 19.4Mbbls/d from 28.2Mbbls/d in 2012.

The Canadian Division's liquids volumes were higher primarily due to the extraction of additional liquids volumes at the Musreau plant in Bighorn and the Gordondale plant in Peace River Arch and successful drilling programs in Peace River Arch and Bighorn. The U.S. Division's volumes were higher primarily due to renegotiated gathering and processing agreements. It resulted in additional liquids volumes in Piceance and Jonah and successful drilling programs in oil and liquids-rich natural gas plays.

Net earnings totaled $730 million, which increased, primarily due to the inclusion of an after-tax non-cash ceiling test impairment of $1,695 million in 2012 and also due to higher unrealized hedging gains of $879 million after tax. The gains were offset by a higher non-operating foreign exchange loss and a lower deferred tax recovery.

One of the best attributes of Encana besides its amazing asset base is its discipline in maintaining low operating costs. The next chart illustrates a comparison of these costs with several peers: Apache Corporation (APA), Chesapeake Energy (CHK), Anadarko Petroleum (APC) and Devon Energy (DVN) among others.

Source: Encana's Corporate Presentation, August 2013

Capital investment during the first six months of 2013 was $1,354 million compared to $1,917 million in 2012. Capital investment in 2013 reflects the company's disciplined capital spending. It is focused on investment in Encana's highest return resource plays, investment in opportunities where development has demonstrated success and executing drilling programs with joint-venture partners.

Development of resource plays continued in Peace River Arch, Bighorn, Cutbank Ridge, Piceance and Haynesville. Investment in prospective oil and liquids-rich natural gas plays was focused on the Duvernay, the DJ Basin, the San Juan Basin, the Tuscaloosa Marine Shale and Eaglebine.

Regarding its financing capital, Encana's current portion of long-term debt outstanding was $1,500 million at the end of Q2, compared to $500 million totaled in the previous quarter. Encana's long-term debt, excluding the current portion, totaled $6,133 million at Q2 and $7,175 million for the previous quarter.

ECA Total Long Term Debt Chart

Encana has a massive long-term debt-to-equity ratio of 115.54, compared to an average of 72.76 of its industry. The management is using a huge part of its financing capital to finance its operating activities instead of ensuring its growth more slowly with the cash generated from its operations.

As a result, its interest expenses are increasing since 2011, amounting to date at $141 million. At some point, the high-level of debt could have perverse effects on its cash flow and will need to be addressed in order to prevent some unnecessary divestitures.

ECA Interest Expense Chart

At the end of Q2, Encana had an available, unused committed revolving bank credit facilities of $4.3 billion and unused capacity under a shelf prospectus for up to $4.0 billion.

ECA EV / EBITDA TTM Chart

Currently, Encana has an EV/EBITDA multiple of 12.64x, the stock trading slightly at a discount compared to the average of its peers of 15.95x. However, its long-term growth potential is better than Chesapeake Energy, a heavy-weighted natural gas producer, which trades significantly lower with a multiple of 6.84x.

Future Outlook

According to Encana's strategy to shift its production towards more liquids for the remainder of the year, the company expects to grow that portion by advancing the development of its liquids-rich plays in Duvernay and Clearwater. Notably, it plans to use deep-cut processing capacities. Encana expects a compound annual growth rate of about 50% for the period between Q1 of 2012 to 2013 year's end with its emerging liquids production.

Furthermore, the gas producer will complete the evaluation of its emerging plays and execute its commercial oil and NGL programs with growing volumes in DJ Basin, Jonah and Piceance.

Encana expects its total production of natural gas between 2,800-3,000Mmcf/d for 2013. In addition, the liquids production is expected to reach between 50-60Mbbls/d.

(click to enlarge)

Source: Encana's Corporate Presentation, August 2013

In 2013, the company plans to continue focusing capital investment in Encana's highest return resource plays, investing in opportunities where development has demonstrated success and attracting third party capital investments. The following slide in Encana's Presentation of August 2013 illustrates how third party capital is beneficial.

Third party capital investment advances development of the company's reserves and resources, recognizes the value of its assets and provides additional financial flexibility.

In addition, third party investment reduces the risk of early life plays and maintains capital and operating efficiencies on mature assets. The next slide shows the leverage projections with completed joint-ventures, partnerships and farm-outs to accelerate value.

Encana has a high quality asset base with tremendous potential. Its estimated proved and probable reserve is at 20.7Tcfe (trillion cubic feet equivalent) and its best estimate of contingent resources totaled 45.4Tcfe.

Source: Encana's Corporate Presentation, August 2013

Furthermore, the gas producer has approximately 30 years of producing life, based on proved reserves plus low estimate contingent resources while it has approximately 50 years based on best estimate contingent resources. The following chart depicts the life cycle of Encana's resource plays. We can see that liquids will play a larger part in the production than in the past.

Source: Encana's Corporate Presentation, August 2013

Bottom Line

As we have seen, Encana has a tremendous asset base of producing and emerging plays in North America. Approximately 64.5% of its net acres of land are still undeveloped, thereby representing an enormous potential for growth.

Encana offers $0.80/share in dividends to its shareholders. The dividend yields currently a neat 4.64%, significantly higher than its industry's average of 1.56%. It definitely adds to its overall value. Morningstar assessed Encana's fair stock value at $19/share while the stock currently trades around 17.20$/share, slightly at a discount.

Here are the upsides from which I believe Encana's stock is bullish:

  • An asset base of more than 10.92 millions in net acres of land with tremendous potential
  • Liquids production shift provides less exposure to volatility of natural gas prices and a more balanced portfolio
  • Substantial generated cash flow and emerging plays will ensure a steady growth
  • Low operating costs offer a great advantage over its peers
  • An efficient third-party capital model that speed up its growth value
  • A proved and probable reserve of 20.7Tcfe and best estimate of contingent resources totaling 45.4Tcfe
  • An appealing dividend that yields about 4.64%

Some liabilities need to be addressed in order to maximize its potential:

  • Several emerging assets are being developed at the same time, which require large amounts of capital
  • A substantial long-term debt that reveals the heavy burden in debt, costing a whopping $141 million in interest expenses and still rising
  • A slightly lower EV/EBITDA multiple compared to the peer group average is suggesting that Encana's total debt is impeding its long-term growth
Source: Why Encana's Asset Base And Growth Potential Makes It A Favorite In The Industry