When it comes to the oil and gas industry, assets matter a lot. For companies operating here, there's nothing more important than reserves, rigs, submersibles, and refineries. However, these assets must be capable of generating profitable returns.
Value for money
These returns indicate whether a given company has the capability of using its assets efficiently and profitably. After all, it makes little sense for an exploration and production company to have a lot of acreage, but not the ability to pull out the oil (or natural gas, for that matter) within. In short, it pays to find out how valuable these assets are to the company.
Here, we will find out whether a given company's assets are profitable and efficient compared with its peers based on some important metrics:
- Return on assets, or net income divided by total assets shows how much the company is earning compared against the assets it controls. The ratio is an indication of how effectively the company is converting the money it has invested in reserves, property and other equipment into net earnings. Higher the value, more profitable the assets are. The metric is pretty useful when used as a comparative measure -- against peers and also against the industry in general. A value greater than 5.8% is what investors should be looking for in this industry.
- Fixed-asset turnover ratio, or revenues divided by total fixed assets (like plant, property, and equipment). Fixed assets form a major chunk of total assets for companies in this industry. This metric shows how efficiently the company is using its fixed assets to generate revenues. The higher the turnover rate, the better. A value above 0.6 looks pretty good.
- Total enterprise value/discounted future cash flows shows how expensive the company is when compared against its standardized future cash flows. The denominator indicates the total present value of estimated future cash inflows from proved reserves, less future development and production costs, discounted at 10% per annum. It's based on today's energy prices and doesn't give any credit for unproved reserves.
With these factors in mind, let's take a look at Encana
Return on Assets (TTM)
Fixed-Asset Turnover Ratio
Pioneer Natural Resources
Source: S&P Capital IQ; TTM = trailing 12 months.
Encana's assets don't seem to generate great returns compared with some of its peers. Additionally, at 1.3%, its ROA is much below the industry average. Its fixed-asset turnover isn't the best, either.
The company's strategy to increase natural gas production could backfire given the lousy market conditions for this commodity. Encana has agreed to sell its North Texas natural gas properties for $975 million, and it recently completed a debt offering of $1 billion. It seems the company is in dire need of cash. Investors should dig deeper.
Deeper analysis suggests that the company is toward the cheaper side when compared with peers' future cash flows from proved reserves. However, this might be justified. Keeping these figures in mind, I believe the stock is priced fairly relative to its book value.
Foolish bottom line
This isn't the only criterion you can use, although assets generally indicate how oil and gas companies have been faring in terms of operations. You can get a more comprehensive understanding by digging deeper. However, on the surface, Encana doesn't seem to be doing fine.
We, at Motley Fool, will help you to stay up to speed on the top news and analysis on Encana. You can start by adding it to your watchlist.