The struggles for Encana (ECA) shareholders have carried over from 2018 and continued into 2019. Year to date, Encana's shares have dropped 29% at the time of this writing after including dividends. In relation, the SPDR Oil and Gas ETF (XOP) has lost 17% over the same time frame. Over the past two years, the ECA shares have lost a whopping 61%, significantly underperforming the SPDR Oil and Gas ETF (XOP), which has declined 33% over a similar period.
Over the course of two years, ECA has gone through significant changes. In November 2018, it announced that it was acquiring Newfield Exploration in an all-stock merger and also took on all the outstanding debt that was on NFX's balance sheet.
As a way to assuage the resulting shareholder dilution, ECA announced a share buyback and a 25% bump to its dividend. This deal was completed in February 2019. Investors have been less than cheerful of the "new" Encana which now features a bloated balance sheet, a vast portfolio that spans the US and Canada and a seemingly neverending bear market in hydrocarbon prices. The natural remedy to a bloated balance sheet and a wide-ranging portfolio is surgical execution and cost control aka control what you can control. With this in mind, the key questions for investors going into Q3 2019 earnings will be:
Encana will experience sequential volume decline in the Anadarko basin as the number of new TILs (revenue producing wells) continues to decline alongside the natural decline in producing wells. However, over the long term the Anadarko is expected to demonstrate volume increases for ECA. In the Anadarko basin, the near-term focus will remain on well cost reductions. The company has targeted reducing well costs by $1M through a combination of reduced sand costs, completion costs and the renegotiation of contracts with the service companies. This should result in a lift to well profitability and payback while also allowing ECA to demonstrate increased recycle ratios in the basin.
The Permian basin is the third largest production play for ECA. Productivity in the Permian has been strong over the past four years. However, the number of new TILs is for the quarter are expected to decline.
Across Encana's portfolio, Q3 production will likely come lower versus Q2 2019 and Q4 will move lower still. The shape of the production volume from a quarter over quarter perspective has been well communicated to the market, therefore barring a big change to the negative, a flat to a slightly down quarter will be well-received. The investor focus will remain on well-costs and ECA's delivery on synergies from the NFX acquisition.
ECA's CAPEX outlook in 2019 was front-end loaded and through the first two quarters, the CAPEX trends have continued to materialize as expected. Any large deviations from the current plan in 2019 and into 2020 will likely place negative emphasis on three things in particular -
We often times see some bread crumbs being dropped by management as a gauge investor feedback. During a recent road show management did not allude to any material changes to spending. Similar comments around CAPEX were noted in several analyst notes that I have read. For this reason, I continue to think that ECA's CAPEX will continue to roll out as planned without any large deviations.
Encana has been buying back its own shares. At the end of July, 2019, Encana had bought back and cancelled 10% of its shares outstanding. The company recently concluded a substantial issuer bid (“SIB”) process and retired almost 47M shares. I remain keen to see if further buybacks will be announced. My expectation is that if Q3 is better than expected and Q4 is looking healthy, we may see a boost to the previously announced buyback plans.
I remain particularly optimistic towards the possibility of further buybacks and continued strength because of insider buying trends.
Insiders have continued to add to their holdings. Not only have insider purchases been frequent, it is the breadth of buying that is encouraging as management, officers, directors and the CEO have all been buyers of their own stock at existing market prices over the past year. The buying has continued into Q3 2019. This should be a good sign for general investors.
The setup for the upcoming Q3 2019 ECA print is benign and perhaps boring. This is good especially considering the volatility we have seen in the oil and gas space and with Encana in particular. Q2 2019 delivered as expected and the takeaway from management roadshow and analyst notes appears to be Q3 will be more of the same. The biggest headwind in the medium to long term remains hydrocarbon pricing and in particular liquids pricing.
However, in the near term as long as ECA executes on its plans, it will be able to deleverage its balance sheet which should provide significant support to its shares. It appears to me that ECA is attempting to carve out out a long-term bottom here. I am keenly paying attention to Q3 results for further confirmation of bluer skies ahead.
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