Analyst upgrades Encana to ‘buy’

No longer among ‘bad balance sheet’ companies

C A L G A RY • Encana Corp. is no longer one of the “bad balance sheet” companies in the oilpatch, and at least one analyst expects its shares to rise as it focuses on new drilling in Texas.

Citi Research managing director and oil and gas analyst Robert Morris upgraded Encana shares to a “buy” rating in a research note published Friday and upped his price target on the U.S. listed shares to US$13 per share from US$10 per share. (They closed Friday up 3.7 per cent at US$10.47)

Morris said in an interview that Encana’s shares have lagged over the last five years because it was overexposed to low-growth natural gas assets, underexposed to oil assets and highly leveraged.

After five long years though, he thinks the company’s stock performance is due to change in part because it raised over US$1 billion in equity, and is using part of the proceeds to pay down its debts.

“In 2015, by far, the biggest single factor for relative performance in E&P (exploration and production) stocks was debt metrics and leverage on the balance sheet — more so than production growth, more so than oil and gas mix” Morris said. In Encana’s case, he said, “The overhang of the debt has been fixed.”

Encana closed its equity offering in late September. The company said it would allocate roughly half of the proceeds to pay down debt — a move that Morris said will help the company maintain an investment-grade credit rating — and the other half to its capital program next year.

Encana will host its annual investor day on Wednesday in New York, at which point Citi expects the company will announce a capital budget of US$1.7 billion for 2017. The bank also expects the majority of that capital to be allocated to drilling in the Permian basin, which is a light oil formation in West Texas.

The company, once the largest natural gas producer in Canada, has been on a multiyear mission to rebalance its production mix under president and CEO Doug Suttles. Morris expects Encana will announce a five-year plan this week to grow its oil and liquids production to the point where it will comprise 48 per cent of Encana’s portfolio in 2021, compared with 35 per cent today.

“Doug Suttles has done a lot to change the asset mix of this company,” Morris said. “But in making that transition they took on a lot of debt.”

There are other assets in Encana’s portfolio that are up for sale, which should further help reduce Encana’s debt, including the Deep Panuke offshore gas project in Nova Scotia, but Morris said the company does not need to sell those assets to remain in investors’ good books given its recent debt reduction efforts.

The recent equity offering, he said in his research note, removes Encana “from the ‘bad balance sheet bucket’ and should enable it to maintain an investment grade credit rating.”

Not everyone is as enthusiastic as Morris about Encana’s prospects. According to Bloomberg, the average target price among the 24 analysts covering the company is US$10.77. Only 10 rate it a buy.

AltaCorp Capital analyst Nicholas Lupick upped his price target on the stock from $8 per share to $9 on the Toronto Stock Exchange after the equity issue but maintained an underperform rating on the stock (The shares closed at $13.71 in Toronto Friday). Lupick noted the funds reduced Encana’s net debt by 22 per cent and that debt reduction offset the dilutive effects of the equity raise on the stock.

Despite the dilution, Lupick said he viewed the capital raise “positively.”