Off and running
We flagged Encana (ECA) as a buy at $42.50 just over two months ago. Since then the shares have climbed steadily in tandem with buoyant energy prices. A strong correlation is hardly surprising. The company is amongst the largest holders of gas and oil resource land onshore North America, and is a technical and cost leader in the in-situ recovery of oil sands bitumen. As such Encana offers robust leverage to rising oil and gas prices. Solid first quarter results give further credence to this view.
| "...two projects underpin the company's longer term plans to reach 500,000 barrels or more per day of bitumen production by 2015." |
Investor sentiment towards Encana remains buoyant. Since our last review in March (FAT124), the stock has extended the firm rally away from the February low of $39.54 to hit $53.70.
Financial highlights from the first quarter include operating earnings increasing 19 percent to $694 million due to higher oil and gas volumes along with strong prices. Total sales ticked up 7 percent to 4.62 billion cubic feet of gas equivalent (Bcfe) per day. Cash flow from operations, up 20 percent to around $1.7 billion, enabled the company to reward shareholders with a 33 percent increase in the dividend to 10 cents per share.
During the period, Encana added two new key resource plays to the unconventional portfolio bringing the total to 12. Quarterly production at Bighorn in central Alberta rose 31 percent to 72 million cubic feet of gas per day (mcfd). This year the field should produce between 80 million and 90 million mcfd, with an un-booked resource potential of around 2 trillion cubic feet of gas.
Meanwhile the Christina Lake oil-sands development in northeast Alberta has the potential to be the company's largest in-situ project. Production will be around 6,000 barrels of bitumen per day (bopd) in 2006. Current expansion should take this to around 18,000 bopd in 2008, with a ramp up towards 250,000 bopd over the next decade. Management estimate Christina Lake has an un-booked resource potential of about 1.8 billion barrels of oil.
Production at the large Foster Creek project was about 36,000 bopd. Capacity will increase to 60,000 bopd by year-end.
We are encouraged by both the near and long term production outlook at Encana. Current expansions at both Foster Creek and Christina Lake will result in bitumen production reaching almost 80,000 bopd within the next 2 years. These two projects underpin the company's longer term plans to reach 500,000 barrels or more per day of bitumen production by 2015.
Elsewhere Encana received approval for the Jonah infill drilling project - the company's most economic resource play. Jonah produced an average of about 460 MMcfd in the first quarter. Production is set to reach between 800-900 MMcf/d over the next 5 years.
Encana's Canadian oil sands assets clearly have tremendous potential. Production from in-situ oil-sands operations remained steady through the quarter - averaging 48,000 barrels per day. However these properties contain an estimated 40 billion barrels of original oil in place. Recoverable resources are between 5 and 10 billion barrels.
Management continue to advance downstream development options for the oilsands assets which include the formal process initiated last fall of soliciting proposals from specialists with demonstrated expertise in downstream operations. Encana is targeting the third quarter for an announcement of their comprehensive oil-sands business strategy.
We remain impressed by Encana's growing reserve and resource base. In 2005 proved reserves rose 20 percent to 17.7 trillion cubic feet equivalent. Unbooked resource potential increased a massive 60 percent to approximately 39 trillion cubic feet equivalent. The oil component of this resource grew 250 percent to 3.3 billion barrels, due largely to revised estimates for Foster Creek and the commercialisation of Christina Lake.
Sustained levels of capital investment should drive further reserve upgrades in our opinion. Upstream capital investment from continuing operations was around $1.9 billion in the quarter.
We are impressed that Encana has been able to keep a lid on costs despite inflationary pressures. Operating costs for continuing operations averaged $0.80 per million cubic feet of gas equivalent (Mcfe). Management have implemented initiatives to keep expenditure in check, including long-term contracts for drilling services, and a disciplined approach to capital investment. We believe this should ensure that Encana remains amongst the lowest cost operators in the industry.
From a balance sheet perspective, Encana is in sound shape. Net debt to market capitalisation and EBITDA (earnings before interest, tax, depreciation, and amortisation) now stands at just 26 percent and 0.6 times respectively. Encana has been able to shore up the balance sheet following a series of non-core asset sales worth around $3.5 billion. As a result the company has ample liquidity to engage in capital enhancing initiatives - around 21.3 million shares were bought back during the quarter.
Although the stock price has recovered strongly since February, Encana is not showing any signs of fatigue at this time. We believe downside risks are limited with initial support around $51. Recent consolidation lows provide additional support at $49.75. With upward momentum now re-established, we believe Encana can extend above $53.70 in the near to medium term. In time, a retest of October's all-time high of $59.82 is achievable, in our opinion.
We remain steadfast in our view that the huge potential of Encana's oil sands assets creates substantial leverage to a bull market in energy. Oil has breached $70 a barrel in recent weeks and we are firmly of the belief that $100 a barrel is a realistic long term target, making exploitation of oil sands resources highly economical. Oil supply and demand fundamentals remain supportive of higher prices in our opinion, Geo-political tensions across the Middle East and supply disruptions in places such as Nigeria look set to underpin energy prices for some time.
From a fundamental perspective Encana offers sound value with a price earnings multiple around 10 times. Accordingly, Encana will remain firmly held in the Fat Prophets Portfolio.
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As at the date at the top of this page, Directors and/or associates of the Fat Prophets Group of Companies currently hold positions in Avexa (AVX), Evolution (EVN), Cerro Resources (CJO), Energy Action (EAX), Mt Isa Metals (MET), Telstra (TLS), Woodside Petroleum (WPL), ANZ (ANZ), Austar (AUN), Carsales.com (CRZ), Gold Road (GOR), IOOF Holdings (IFL), Magellan Financial group (MFG), Paladin Energy (PDN), QBE Insurance (QBE), Platinum Australia (PLA), Datasquirt (DSQ), Hodges Resources (HDG), Newcrest Mining (NCM), Oil Search (OSH), Zambezi Resources (ZRL), Auroa Minerals (ARM), Billabong (BBG), Pioneer Resources (PIO), Runge (RUL), Westpac (WBC). These may change without notice and should not be taken as recommendations.