Image source: Encana Corporation.
This past year has been an outstanding one for Encana's (OVV 1.49%) investors given that the stock price has more than doubled. Fueling that remarkable rise was the company's ability to turn its balance sheet from a liability to an asset while also reducing costs to the point where it can restart its growth engine at much lower oil prices. Here's a look back at three smart moves that made a huge difference in the company's fortunes.
Sharpening its focus on the core
Encana spent much of the past few years reshaping its portfolio, which included acquiring growth-focused shale assets and shedding positions that didn't fit in with the new core. This transition continued in 2016 with the company closing the sale of its Gordondale assets while also working with a buyer to close a deal it signed in late 2015.
The Gordondale sale provided Encana with 625 million Canadian dollars in cash as well as reducing its midstream and downstream commitments by more than CA$100 million. That enabled the company to not only cash in on an asset where it had no plans to drill in 2016 but also reduced costs, which pushed it closer to the point where it could grow at lower commodity prices. In addition to that, the company finally closed the $900 million DJ Basin asset sale in late July. While it took Encana much longer than anticipated to close that deal, its patience paid off because the company received a large cash infusion to accelerate its debt reduction efforts.
Firming up the balance sheet
Those two asset sales provided Encana with more than $1 billion in cash for debt reduction. While that was a step in the right direction, the company wanted to go even further than asset sales alone could take it. That led the company to complete a $1 billion equity offering in September, which gave it even more cash for debt reduction as well as the ability to pre-fund a portion of its 2017 capex plan.
As a result of these balance sheet improvement efforts, Encana has reduced its debt by $3 billion since the end of 2014. That reduction enabled the company to maintain an investment-grade credit rating while pushing out its nearest debt maturity to 2019. Furthermore, it provided the company with ample financial flexibility to fund growth going forward.
Image source: Encana Corporation.
Releasing a premium plan
Another major focus of Encana over the past few years has been to get its costs down so that it could thrive at much lower commodity prices in the future. These efforts led to a series of technical innovations, efficiency gains, and other cost reductions that pushed Encana's drilling costs down to where it can achieve a 35% after-tax rate of return on its best drilling locations at $55 oil and $3 gas. That premium drilling inventory, as well as a much stronger balance sheet, enabled Encana to announce a new five-year growth plan in October. The strategy puts the company on pace to deliver 60% production growth by 2021, fueled by a 300% increase in cash flow.
A fundamental driver of that plan is the company's decision to focus its future capital dollars on drilling liquids-rich wells, particularly in the Permian Basin. That legacy oil basin is the key to the growth strategies of many oil companies these days thanks to its low costs and high oil output. For example, Permian Basin-focused driller Concho Resources (CXO) intends to use its prime position in that play to boost production by 18% to 21% next year, with oil output growing by at least 20%. Further, Concho Resources believes it can deliver 20% compound annual production growth through 2019 thanks to the Permian. Meanwhile, fellow Permian-focused driller Diamondback Energy (FANG 1.70%) expects to grow its production by a stunning 60% next year. Fueling Diamondback Energy's growth is a transformational deal that will significantly boost its Permian position as well as the fact that it can earn a more than a 100% rate of return on its best Permian wells at current commodity prices. Given the Permian's returns and growth potential, Encana's move in late 2014 to acquire a core position in that play could turn out to be its best move ever.
Investor takeaway
Encana spent much of this past year putting the finishing touches on its transition plan. These steps included completing the last of its non-core asset sales, strengthening its balance sheet, and continuing to push down costs. The net result of these efforts is that Encana can start growing again in 2017. While the company is not going to grow as fast as pure-play Permian players like Concho Resources or Diamondback Energy, Encana still has the potential to create substantial value for investors over the next few years.
