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This Oil Stock Is Transforming Into a Cash Flow Powerhouse

By Matthew DiLallo - Feb 21, 2018 at 6:48PM

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Encana Corp is generating much more cash flow than it anticipated, which could give it the money to richly reward investors in the coming years.

One thing evident in Encana's (OVV -1.56%) fourth-quarter results was that the Canadian shale driller had reached the turning point, going from a cash flow consumer to a cash flow producing machine. Overall, cash flow jumped 60% last year to $1.3 billion. While that wasn't quite enough to cover its capital program for the year, rising cash flow in 2018 and beyond should finance future spending with plenty of room to spare. 

Encana's cash flow generating capacity was a central theme on the company's fourth-quarter conference call, in which CEO Doug Suttles provided a glimpse of the upcoming gusher and what the company might do with that windfall.

An oil pump with stacks of $100 bills in the back ground.

Encana is about to pump out a gusher of free cash flow. Image source: Getty Images.

Outperforming the plan

On the call, Suttles reminded investors of the five-year plan the company outlined at its investor day last October. Thanks to continued innovation, the company was on pace to "deliver a cash flow compound annual growth rate of 25%" thanks to a returns-driven strategy that would focus on drilling for high-margin liquids in the best shale regions. Further, "demonstrating the quality of this plan, we thought we could deliver all of this while generating free cash flow of about $1.5 billion at a $50" oil price and $3 for natural gas over that five-year time horizon. However, he pointed out that "with only a modestly higher oil price of $55, we now believe we can generate about $3 billion of cash flow over this five-year plan. This is double what we showed last October." In fact, at $55-a-barrel oil, the company "could generate approximately $500 million of free cash flow next year." Meanwhile, there's ample upside to that since crude is currently in the low $60s.

With so much cash coming down the pipeline, Encana is well on its way toward meeting its balance sheet goal to get leverage down to 1.5 times debt-to-EBITDA. In fact, Suttles pointed out that its debt ratio is on pace to drop to such a degree "over the course of the five-year plan [that] this could provide almost $2 billion of additional financial capacity." That led the CEO to declare that "all told, this works out to about $5 billion of cash that is available in our business over the 2018 to 2022 period."

A close-up of a stack of $100 bills.

Investors could be seeing more green from Encana in the coming years. Image source: Getty Images.

Starting to send back the excess

Will all the money potentially coming in the doors over the next few years, and a boatload of cash sitting on the balance sheet from recent asset sales, it "has accelerated our discussions about the best way to use this capital to maximize shareholder returns," according to Suttles. He continued by saying that:

As we see it, there are broadly three different groups of actions we can take. First would be a direct return to our shareholders. This would include dividends or share buybacks. Second are portfolio value creation options that would be accretive to our five-year plan. And third would be a bucket we call resiliency. This would include options that reduce our risks to lower commodity prices. In our view, it makes sense to keep all of these alive.

The CEO went on to say that "after reviewing these alternatives, we have decided to initiate a $400 million share repurchase program," which the company will fund with cash on hand. 

That cash return, however, is only the beginning, with the company likely following in the footsteps of peers that have progressively increased shareholder payouts in the past year. Canadian oil giant Suncor Energy (SU 1.43%), for example, started off small with a 10% dividend increase last February. However, with its business continuing to deliver strong cash flow, Suncor announced plans to buy back 2 billion Canadian dollars ($1.6 billion) of stock in April. Those increasing cash returns continued this year, with Suncor announcing that it would boost the dividend an additional 12.5% to go along with another CA$2 billion share buyback program.

Meanwhile, U.S. oil giants ConocoPhillips (COP 1.30%) and Anadarko Petroleum (APC) have progressively increased their cash distributions to investors. ConocoPhillips started off in late 2016 with plans to repurchase $3 billion of its stock as it completed asset sales. However, it doubled that buyback plan last spring before extending it further in the fall, bringing the total authorization up to $7.5 billion. In addition to that, ConocoPhillips boosted its dividend 6% last year and another 7.5% in 2018. Anadarko followed a similar pattern, announcing a $2.5 billion buyback funded with cash on hand last fall. However, it added $500 million to that plan this year due to its rising free cash flow while also boosting the dividend five-fold. Given that pattern and their success in creating value for investors so far, it wouldn't be a surprise to see Encana announce steady increases in the cash heading to investors in the coming years.

Why investors should sit up and take notice

Despite transforming into a cash flow machine, Encana's stock has fallen about 14% in the past year. However, its fortunes could be about to change as more money starts flowing back to investors. That's because, with upward of $5 billion at its disposal, this $10 billion company could retire a significant chunk of its outstanding shares in the coming years if it uses the bulk of that money on share buybacks. It's a catalyst that could ignite the stock and potentially fuel market-crushing returns.

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