EnCana (OP/A): Oil sands momentum rising, natural gas growing pains being addressed - Goldman Sachs - April 26, 2006
We continue to believe EnCana has a high-quality North American onshore asset base that can yield superior organic absolute and per-share production growth over the next decade. The company continues to experience growing pains -- the Street focuses much more on production growth for smaller E&Ps but on returns and free cash flow for larger E&Ps, and EnCana has struggled to rejigger its former aggressive growth bias to also shore up capital discipline. However, we believe expectations remain quite low, while capital spending seems to be generally within the company's budget and production is on track. We believe EnCana's oil sands assets are not being reflected in share price valuation, which, now that the stock has rebounded, is the main driver of upside that underlies our OP/A rating.
GROWING PAINS IN MANAGING NATURAL GAS PORTFOLIO CONTINUE EnCana shares and EnCana management are still recovering from pressure applied by the Street related to the company's capital spending and operating costs, which over time has built up as the company rapidly expanded its unconventional gas portfolio. The disparity of expectations between small and large companies is clearly seen when comparing EnCana versus other, mostly smaller unconventional gas companies. Investors in Quicksilver Resources (Horseshoe Canyon CBM, Barnett Shale), Ultra Petroleum (Pinedale Anticline/Jonah), Bill Barrett (Rockies exploration, Piceance Basin), among others, care less about current free cash flow/returns and more about resource base and production growth. Investors in large-cap E&Ps, on the other hand, focus more on returns and free cash flow versus simply growth. We do not expect these perceptions to change. EnCana management is beginning to adapt to the new playing field with greater focus on reining in spending and focusing drilling more in fairways of key resource plays and slightly less on trying to extend plays given service cost inflation.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Oil sands downstream joint venture announcement. We continue to believe that in-situ oil sands assets generally and EnCana's oil sands portfolio specifically are not being fully valued by the Street, and we see continued upside to EnCana stock as greater credit is given. We see three catalysts along the way for EnCana stock to afford greater value for oil sands: First, we expect EnCana to announce in the next six months a joint venture partnership with a major or domestic oil company to integrate EnCana's bitumen assets with upgrading and/or refining. We believe this deal will lend some credibility to the potential for EnCana to produce a company-estimated 500,000 bpd of bitumen by 2015. Second, the potential separation of oil sands assets into its own entity/subsidiary. Based on comments from CEO Randy Eresman on both the earnings conference call and at the recent IPAA conference, we believe that EnCana is considering a potential spinoff of at least part of its oil sands portfolio once the integration deal is complete. Third, as EnCana and the rest of industry can demonstrate consistent performance among existing and new in-situ projects, both in terms of consistent production growth and a consistent/falling steam-oil ratio, companies that have in-situ exposure can receive more credit. Suncor Energy (OP/A), EnCana and Nexen (IL/A) are most levered to any narrowing of the gap between how in-situ oil sands assets are valued versus mining assets.
(2) Piceance Basin production growth and returns. The Piceance Basin continues to be a key focus point of opportunity for EnCana, though asset quality is more variable than both we and the company initially believed. EnCana's pullback in drilling on the fringes of delineated acreage has reduced expectations for production growth for this year, but we believe that the company continues to have very attractive not-yet-delineated acreage that, in a lower service cost environment, could ultimately lead to additional resource upside. Additionally, as infrastructure continues to be expanded in the Piceance we believe drilling can accelerate without a negative impact on returns. In addition to the Piceance, we see rising momentum from nearby exploration opportunities such as the Paradox Basin.
(3) Performance of emerging resource plays. We continue to believe that EnCana will unveil new "resource plays" over time, as it did on April 26 with its tight gas Bighorn play in west Central Alberta. Even after deducting Bighorn, unidentified Canadian natural gas production represented 48% of total 1Q 2006 Canada gas production, and we believe that there are embedded resource plays that have not yet risen to materiality that have growth potential. In late 2006, we expect production to increase from Cutbank Doig, a subset opportunity within the Cutbank Ridge field that EnCana identified in October 2005. We believe performance of recently-announced plays such as Bighorn and Cutbank Doig, along with future new plays can be a catalyst for EnCana shares.
1Q 2006 RESULTS IN LINE WITH EXPECTATIONS EnCana reported 1Q 2006 operating and financial results generally in line with expectations. Adjusted EPS was $0.80 versus our estimate of $0.87 and First Call consensus of $0.97. Operating cash flow of $1.69 billion was slightly above our estimate of $1.61 billion. Production (excluding Ecuador) of 4,320 MMcfe/d was in line with our estimate of 4,325 MMcfe/d. All-in unit costs of $23.94 per BOE were slightly above our estimate of $21.96 per BOE.
UPDATING ESTIMATES We are updating our 2006-2010 EPS estimate to reflect revised assumptions for production and minor other adjustments. Our 2006 EPS estimate is now $3.33 ($3.40 previously), reflecting the 1Q result, while our 2Q, 3Q, and 4Q 2006 EPS estimates are unchanged. Our 2007 EPS estimate is now $5.56 ($5.71 previously). Our 2008-2010 (normalized) EPS estimates are now respectively $1.87, $2.01, and $2.15, down from $1.98, $2.13, and $2.26 previously.
Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Brian Singer, Arjun Murti. |
