Encana (NYSE:ECA) recently completed a major overhaul of its portfolio, balance sheet, and cost structure to transform the company into a low-cost growth machine. Now, it is ready to put its new growth plan into action. Here's what CEO Doug Settles wanted investors to know about its plan, and how it compares to those from competitors.
It's all about the cash flow
Settles recapped Encana's five-year growth plan on the company's third-quarter conference call. He started off with this:
Encana's growth potential is second to none among our competitors. We expect to grow cash flow by more than 300% over the next five years by both increasing production and, more importantly, increasing our margins at flat [commodity] price[s]. We expect that by the end of 2021, we will grow total company production by over 60%. This growth consumes a fraction of our 2,000 premium return inventory locations. These are wells that deliver at least a 35% after-tax rate of return at a flat $50 WTI oil price and a flat $3 NYMEX gas price, which translates to a corporate return in the mid- to high teens.
Settles notes that the core of Encana's strategy is to grow its cash flow by triple digits over the next five years. It will achieve that goal by expanding production that expands its margins. That is because the company will focus its attention on drilling its best well candidates, which are those that can deliver robust returns at lower oil and gas prices. That said, even after drilling all these wells, the company will only exhaust a fraction of its current inventory, meaning there's plenty of growth left in the tank beyond 2021.
Blazing a trail
That focus on delivering cash flow growth by focusing on growing production that drives margin expansion is something that was unique to Encana when it initially released its five-year plan in early October. Before that, most of its peers focused only on the rate that they could grow production in the future while still living within cash flow. For example, Pioneer Natural Resources (NYSE:PXD) was one of the first shale drillers to release a long-term growth plan this past July. At the time, Pioneer Natural Resources commented: "We are on a trajectory to deliver compound annual production growth of approximately 15% while maintaining a net debt-to-operating cash flow ratio below 1.0 times through 2020 at mid-July strip prices. We also expect to spend within cash flow in 2018 assuming an oil price of approximately $55 per barrel."
However, in November Pioneer Natural Resources updated its plan to add in its cash flow growth projections, noting that "we are on a trajectory to deliver compound annual production and cash flow growth through 2020 of approximately 15% and 25%, respectively." (Author's emphasis.) It is an addition that a growing number of companies are making to their long-term growth plans.
Meanwhile, other drillers are joining Encana by making cash flow growth the centerpiece of their growth plans. For example, when Devon Energy (NYSE:DVN) released its preview for 2017 and 2018 earlier this month, cash flow growth was the focal point. Devon noted that at $55 oil and $3 natural gas, its upstream cash flow should expand by more than 100% next year to $2.5 billion. Because of that expansion in cash flow, the company could steadily ramp up its activities while remaining within cash flow and drive double-digit oil production growth in 2017. Moreover, it saw cash flow jumping by 200% from current levels in 2018, which positioned it to generate stronger growth in 2018. Again, Devon's growth plan is a cash-flow-growth plan first, which it will achieve by delivering high-margin production growth.
The centerpiece of Encana's growth plan is its ability to achieve remarkable cash flow growth over the next few years at around current energy prices. Fueling that growth is its focus on drilling high-margin wells that will deliver an abundance of cash flow. It is a plan that a growing number of rivals are starting to emulate as shale companies shift priorities toward becoming cash-flow machines instead of just production growth companies.