Lean times often call for difficult decisions. To cope with the lean times caused by low oil and gas prices, Encana Corporation (NYSE:ECA) has been shedding valuable assets over the past two years in order to focus on its four core assets: the Permian, Eagle Ford, Duvernay, and Montney plays. So it probably came as a surprise to some investors that the company recently sold its Gordondale assets from the Montney region in Alberta to Birchcliff Energy (TSX:BIR) for nearly $500 million. Is Encana taking its divestments too far, too fast?
Over the past two years, Encana has made it clear that it will divest assets to focus on its core business and clean up its balance sheet. According to its first quarter financial report, the company has made nearly $3.2 billion in net divestitures over the past two years. Selling off its Gordondale assets continues this trend.
What selling off Gordondale also does, though, is divests assets that were producing 26,000 barrels of oil equivalent per day (BOE/D), of which one third were liquids. But while two thirds of those assets produced natural gas, two thirds of the remaining Montney drilling positions are in condensate-rich areas. It appears that Encana's divestments, in addition to strengthening its four core assets, are also focusing the company on a more liquids-based portfolio.
In Encana President & CEO Doug Suttles' own words, "We are tightening our portfolio and sharpening our focus in the Montney where we expect to grow liquids production to 50,000 barrels per day by the end of 2018. This transaction further strengthens our balance sheet and gives us greater financial flexibility as we look to the future ."
This would actually bring the Montney play closer to the rest of its core assets, which all produce a majority of oil and natural gas liquids. 82% of its Permian Basin production in the first quarter, for example, was oil and liquids .
Working on the balance sheet
As Suttles explains, the divestments also aim to strengthen the company's balance sheet. Encana is heavily laden in long-term debt, which at the end of the first quarter sat at $5.4 billion. With total equity at $5.5 billion, you're looking at a nearly 50% debt-to-total capitalization .
Encana recognizes that overbearing debt can be a burden to operations, particularly with oil price volatility, and actually paid down nearly $500 million in notes in the first quarter. It needs to continue to utilize some of its incoming capital to pay some of this down.
Interestingly enough, during this period of divestments, Encana has seen its cash on hand drop from over $2 billion one year ago to $222 million at the end of the first quarter. Encana issued a large share issuance a year ago to bolster its cash reserves, but then experienced low oil prices while paying down debt. Large capital expenditures and reduced cash flows also contributed to the drop. Over the past six quarters, cash flows averaged $350 million while average capital expenditures were $600 million. It's hard to fault a company for investing in its business, but that can only last so long without adequate cash flow.
Fortunately, almost the entirety of its capital expenditures went into its core business assets, which are considered so valuable because their large reserves and scalability allow for efficient and profitable production .
Foolish bottom line
Focusing on core assets seems to be an industry trend, and Encana has picked four solid plays to build around. Don't underestimate the importance of a strong balance sheet, though, and remember that Encana still has high levels of debt that could weigh on its future performance. Its management seems to recognize this and is already making moves to get its house in order. While the latest divestment might raise some eyebrows at first glance, it actually fits in well with the company's strategy and should pay off if Encana can leverage the opportunity to expand its Montney liquids production as expected.
David Lettis has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.