Encana Corporation: Opportunities-Rich Though Cash Flow-Short
Canaccord Genuity Calls Encana a Hold with a target of $21.50.
The following is an excerpt from Canaccord Genuity analyst Phil Skolnik's Research Report.
We believe Encana Corporation (ECA) is opportunities-rich; it is, however, cash flow-short. We also believe it is exposed to too much natural gas to allow for a swift and meaningful transformation to an oil and liquids weighting in the near term.
This is especially true since Encana’s natural gas production has been outperforming expectations to date, which is what led to the increased 2012 natural gas production guidance as opposed to our previous belief that it was due to less shut in gas.
Additionally, management stated at this week's investors' day that it sees more value in organically growing its oil and liquids production versus using the stock’s high multiple to make an acquisition. While Encana raised its 2012 capex budget by $600 million to $3.5 billion (in order to chase more oil and liquids opportunities), it maintained its cash flow guidance of $3.5 billion despite raising production guidance 5% and keeping its NYMEX gas and WTI crude oil price forecasts unchanged.
What is encouraging for 2013, which is when a large amount of Encana’s hedges fall off, is that management stated that it will not purposely spend beyond cash flows [Editor's Note: Canaccord Genuity's 2013 guidance for Encana suggests a $1.5 billion net cash usage pre-dividend payout] until it has clarity on specific asset sale and joint venture ("JV") conclusions. However, it means that if the JV or asset sale market slows down in light of the current market, Encana will need to dial back spending, and thus slow down its transformation process.
A JV announcement is a potential catalyst here. But at current prices, we estimate that there is ~$1.5 billion or $2/share worth of potential JV built into the stock price. The inability to announce a JV this year would represent ~10% downside risk from here to the stock, while every extra $1 billion above that in JV would equate to about 7% upside potential to the current share price, in our view.
However, based on updated guidance, the stock currently trades at 5.1x 2013 estimated Debt-Adjusted Cash Flow ("DACF"), which is one of the highest in our Canadian Sr. E&P/Integrated coverage universe. We have revised our 2012 and 2013 estimates to reflect updated guidance. We maintain our Hold rating and $21.50/share target price based on 3.5x our estimated 2013 Enterprise Value (the theoretical takeover price) divided by DACF and is supplemented by almost $6.00/share of risked resource upside value for 2013+.
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