Encana swings to a loss
A look at the latest earnings report for Canada's biggest gas producer, along with the prospects for some other players in the sector
by Max Fawcett
Encana (TSE:ECA) reported its 1Q13 earnings on Tuesday, and in it the company swung to a net loss of US$431 million (59 cents per share) on operating earnings of $179 million (24 cents per share). The substantially larger net loss figure is attributable to a $266 million hedging loss – unrealized, as of yet – and a $101 million foreign exchange loss. But even with those numbers stripped out, the quarter was a disappointment, as the company’s operating earnings were down substantially on a year-over-year basis, from the $240 million it posted in 1Q12.
Dirk Lever, the managing director of AltaCorp Capital, appeared on BNN today to talk about the company’s fortunes and those of others in Canada’s natural gas space. Encana’s biggest problem, he says, isn’t so much the pricing environment – which appears to be firming up above $4 per mcf – as it is the fact that it isn’t big enough to move the needle when it comes to LNG contracts with overseas buyers. Yes, he said, Encana is the third largest producer in North America. But the fact that it couldn’t strike a deal with a potential buyer to justify the cost of building out an LNG terminal in Kitimat, B.C., even when it joined forces with Apache and EOG (Encana sold its 30 per cent stake to Chevron, along with some natural gas assets and a portion of a pipeline, late last year) speaks to the enormous scale such a venture requires. “It’s a big player’s game,” he said on BNN.
At current price levels, Encana is able to tread water, with enough free cash flow to meet its drilling and development costs and maintain its levels of production. But in order for it to start swimming, Lever said, one of those bigger players – better yet, a bunch of them – need to open up access to international markets. “For the Canadian producers at the end of the pipe, their end customers are a long way away, so the economics are tougher for them,” Lever said. “They need an export outlet for all the gas that’s coming out of British Columbia and the Deep Basin. It has tremendous potential, but it needs a home.”
That said, he still likes the company, and has an ‘outperform’ rating on its shares. “Part of it is valuation – they have lagged, and they are one of the largest producers. At $4.25 to $4.50, they can generate enough cash flow to match their costs and grow. But, in particular, is the growth on the LNG side [he meant NGL] where there’s been significant growth for them. They grew 20 per cent quarter over quarter.”
As for the other players in the space, Lever likes Peyto (TSE:PEY) for its geographic concentration and resulting ability to drive down costs. “They’re very self-contained, they’re working in a very small area, and they drive their costs down. Where Encana is everywhere, Peyto is in a very concentrated area. They’ve shown terrific growth and paid a dividend.” And while he’s been trying to find another company with a better cost structure than Peyto, Lever said “it’s like trying to find a white crow.”
Despite its premium valuation – or, perhaps, because of it – Lever doesn’t think it’s too late to get into ARC Resources (TSE:ARX), whose shares are trading at a 60 times PE valuation. “People ask me the same question five years ago, 10 years ago about ARC. It’s very well run. They’ve been able to show steady growth over time, and I’m looking at production per share.”
He’s less bullish about Bonavista Energy (TSE:BNP), which recently cut its dividend, but he thinks they should be able to sustain it at that level and with these prices. “They’re hoping that cut is sufficient that they can sustain that dividend and, over time, maybe grow the business. But it’s a tough business.”