Now Is the Time to Follow Encana

Expanded North American natural gas production is not a passing phenomenon, and rising natural gas consumption is funding Encana's (NYSE: ECA  )  turnaround. Encana is hard at work diversifying production, bringing down its debt, and developing some of the most exciting onshore regions in North America.

Encana's debt is not is not as bad as it looks
In terms of raw numbers, Encana's debt load is large. In the first quarter of 2014, it had $6.1 billion in long-term debt and $5.2 billion in equity. This is high for an oil and gas company subject to the volatile energy markets. The good news is that the vast majority of Encana's debt doesn't mature until after 2020. A full 66.6% of its total long-term debt's principal is spread out between 2021 and 2041.

By pushing out its debt, Encana ensures that it is able to stagger its need to access the capital markets. The good news is that improving natural gas prices and changes in production are pushing the company forward. From Q1 2013 to Q1 2014, natural gas went from 90.8% of its Canadian production net of royalties to 86.4% of production net of royalties. Its U.S. operations saw natural gas production net of royalties fall to 88.5% of total production in the same period. 

Thanks to the amount of natural gas in storage hitting new lows, there is a good chance that natural gas prices will remain strong. Higher prices will help Encana get the cash flow it needs to develop its growth plays in the Eagle Ford and elsewhere.

Other big natural gas drillers are successfully turning around as well
Betting on a turnaround can be risky, but there are other companies similar to Encana that have already paved the way. In Q1 2014, Chesapeake Energy (NYSE: CHK  )  managed to push its natural gas production down to 71% of its total production from 76% a year earlier. Chesapeake's total debt-to-equity ratio of nearly 1 is still high, but the company's improved liquids production should bring in enough cash flow to easily make debt payments.

A significant portion of Chesapeake's Q1 2014 capital expenditures went into its liquids-rich Eagle Ford development. Chesapeake's debt schedule is not as diversified as Encana's, but improving liquids production should let Chesapeake retire a portion of its current debt load.

Chesapeake's and Encana's push to bring down debt levels looks even more doable when compared to SandRidge Energy (NYSE: SD  ) . The company can boast that just 50.5% of its Q1 2014 production was natural gas, but SandRidge's total debt-to-equity ratio of nearly 2 is around double Chesapeake's total debt-to-equity ratio.

The challenge with SandRidge can be seen in its production base. Some 85.2% of its $1.22 billion 2014 drilling and completion budget before joint venture carries will be spent in the Mississippian and Midcontinent region. It needs to run a significant capex budget as its production base quickly declines. In 2013 alone its production base fell by 43%.

Follow the leader
In many ways, EOG Resources (NYSE: EOG  ) serves as the example for Encana. From 2006 to 2013, EOG shifted natural gas from 79% of its North American revenue to 12%. By focusing on oil-rich plays, EOG Resources has become the biggest producer in terms of combined Eagle Ford, Bakken, and Permian production.

With a total debt-to-equity ratio of about 0.4, EOG Resources shows that it is possible to grow and develop shale plays without becoming massively indebted. EOG Resources' head start will help it to maintain its position as one of the most prominent unconventional exploration and production companies, but Encana can still follow in EOG Resources' footsteps to repeat some of its success. Encana's upside is that its later entry into shale lets it enjoy the falling well costs and productivity improvements that have already swept the industry.

The future is looking brighter
Encana's turnaround has a great amount of potential. By diversifying into liquids and focusing on a number of high-quality unconventional plays, it should be able to boost its earnings and chip away at its debt load. Someday Encana and Chesapeake may even pose real competition to EOG Resources.

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