EnCana Corp. (OP/A): Analyst meeting highlights resource potential, incremental returns - Goldman Sachs - November 08, 2005
We believe EnCana (OP/A) continues to have a leading position among North American E&Ps in its potential to show robust organic production growth at attractive mid-cycle incremental rates of return. At its analyst meeting, EnCana set a 10%-14% production growth target before share buybacks and addressed some of the concerns regarding its below-average total company returns with extensive project by project detail. We see 3 areas that we believe are not being valued in ECA shares: the Piceance Basin, which could hold 30-40 Tcfe of recoverable resource (even above our estimates); oil sands, an area EnCana is planning to grow to 500,000 bpd in 2015; and exploratory upside which we believe could further extend probable reserves over the next five years. Among large-cap gas-focused E&Ps, XTO Energy remains our top pick; recent weakness in ECA shares we think provides a buying opportunity.
PICEANCE BASIN POTENTIAL MORE SIGNIFICANT THAN OUR ESTIMATES
While EnCana did not revise upwards its unbooked resource potential estimates for the Piceance Basin or its other key growth plays, it did highlight that it believes the ultimate recoverable resource potential for the Piceance could be between 30-46 Tcfe. This is even greater than the 15 Tcfe of potential we had identified in our June 23, 2005 report, "Piceance Basin: potential material upside for super- and small-caps." The company has officially claimed 6.6 Tcf among cumulative production, proved reserves and unbooked resource potential. EnCana's unbooked resource potential estimates are based on delineating just 14% of the company's acreage, and we believe an incremental 5% could be delineated this year which would be additive to 2005 yearend proved reserves and unbooked resource potential. Drilling efficiency continues to improve, though efficiency gains are more than offset by service cost inflation and service/permit-related delays. The company's 2006 expected production from the Piceance was slightly disappointing but, in our view, reflects conservatism regarding future delays in getting wells brought online. A positive result from XTO Energy's first Piceance Basin well (as part of its Exxon Mobil joint venture), expected in 1Q 2006, could be a catalyst for EnCana shares.
FAVORABLE DOWNSTREAM DEAL TERMS COULD ALLOW FOR MORE OIL SANDS CREDIT
EnCana, like many companies that have oil sands leases, is accelerating its production growth plans with intentions of producing 500,000 bpd in 2015. The company has added a third oil sands project -- Borealis -- with recoverable oil reserves of 1.3 billion barrels and expected daily production of 100,000 bpd. Additionally, EnCana now seems more aggressive about ramping up Foster Creek from 35,000 bpd to 150,000 bpd and Christina Lake from about 7,000 bpd to 250,000 bpd. The key differentiating factor in EnCana's oil sands strategy is its aversion to building upgrading capacity. A year ago, the company announced it was negotiating with refiner Premcor and would likely commit capital to expand Premcor's Lima, Ohio refinery to process bitumen/heavy oil. At the analyst meeting, EnCana management strongly suggested that refiners (especially Valero Energy, which bought Premcor earlier this year) are more willing to commit capital towards upgrading refining capacity themselves. A supply agreement (which could involve an asset swap) would spare EnCana having to commit capital, though we remain concerned that bitumen prices will stay quite low considering other oil sands projects planning to come online. If, however, EnCana can arrange a deal that shares some of the risk of widening light-bitumen differentials, this would be positive for EnCana shares. We do not believe that the significant potential from oil sands projects are being factored into EnCana shares, but it may take an acceptable supply agreement for EnCana shares to receive credit.
EXPLORATION OPPORTUNITIES COULD MEANINGFULLY INCREASE LONG-TERM GROWTH
EnCana provided more details on some its key exploration plays, which we believe could further enhance the company's dominant unconventional gas asset base in North America. Five key exploration plays include:
(1) CBM in the Piceance Basin, with potential for 1 Tcfe;
(2) Deep Bossier in East Texas where the company has 62,000 net acres and plans to have four rigs drilling in 2006;
(3) The Maverick Basin in Texas, where the company recently acquired 330,000 acres and is testing the Georgetown carbonates;
(4) the Columbia River Basin, where the company is (finally) drilling its first well and plans about four wells in the next eight months; and
(5) West Texas, where the company has acquired 670,000 acres and is the testing the Delaware Basin as an analog to the Barnett Shale. In addition, we believe the company has exploratory upside in Wyoming, from the Green River Basin, the Vermilion Basin and from Jonah (success from the deep test in the Pinedale Anticline could translate to Jonah). 10%-14%
PRODUCTION GROWTH POSITIVE AND SHARE BUYBACKS WOULD BE ADDITIVE
EnCana initiated a production CAGR of 10%-14% from 2006-09. This is a surprise and is greater than our estimates. EnCana highlighted that it could pursue an asset swap to gain downstream exposure which could decrease its growth guidance. However, management said that capital committed to share repurchase would be additive to capital committed to achieve the company's target growth. In the past, EnCana has slowed its absolute growth rate and increased share repurchase, focusing on a 10% per-share growth rate. The new growth rate essentially increases both the absolute and per-share growth versus previous expectations. We believe this is positive, though admittedly seems a bit aggressive. We have not changed our estimates. In 2006, our estimates reflect production at the upper end of company guidance, and we have greater confidence that the company is being conservative in setting its guidance after having to lower its range somewhat for 2005.
IMPROVING RELATIVE RETURNS IMPORTANT FOR RECEIVING CREDIT FOR GROWTH
Our key concern regarding EnCana remains its below-average reported returns versus other visible growth E&Ps. EnCana addressed these concerns with very detailed project-by-project return assessments, which were generally in-line with expectations. EnCana's return on capital employed has been clouded by a combination of non-cash hedging volatility and acquisitions/divestitures. However, we believe that EnCana's mid-cycle project returns from additional drilling are favorable relative to peers. For EnCana to receive credit for improved returns, the company needs to show an improvement in relative returns, even if its absolute returns remain below average. In terms of free cash flow, we believe that EnCana's capital spending on drilling and acreage expansion should be treated no differently than capital spent by peers for both drilling and acquisitions. EnCana, in our view, gets unduly penalized for having low free cash flow relative to its peers.
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. |
