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We are maintaining our Neutral recommendation on Encana Corporation ( ECA - Analyst Report ) , reflecting its vast natural gas resources and attractive collaborations, partially offset by soft fourth quarter 2011 results and an unstable natural gas scenario.
Headquartered in Calgary, Alberta, Encana is one of the largest natural gas companies in North America with a diverse/high quality portfolio of natural gas assets spread over Canada and the U.S. This provides the company with a huge inventory of reserves and a resource base capable of robust production growth.
Over the past few months, Encana has entered into lucrative alliances with other companies. The deal with Mitsubishi in developing the Cutbank Ridge – one of the most fertile and low-cost resource rich acreages in North America – holds promise of unlocking high productivity in the near term. Additionally, Encana’s pact with AGL Resources ( GAS - Analyst Report ) will also provide a steady supply of liquefied natural gas for its new fueling stations over the long term.
We support Encana’s strategy of disposing assets that do not fit into its long-term growth plan. The company’s divesture program includes the disposition of high cost yet low profit generating assets and a focus on asset base expansion that would render high returns. The net proceeds received from these property sales (more than $1.5 billion in 2011) also render strong financial flexibility to the company.
However, Encana’s performance in the last three months of 2011 has been disappointing for us. The company announced operating earnings per share (excluding one-time items) of 6 cents, below our projection of 8 cents and the year-ago income of 7 cents, primarily due to lower realized natural gas prices.
For 2012, Encana plans to invest about $2.9 billion on capital programs, reflecting a reduction of about 37% from the 2011 level. We believe that lower capital spending on dry natural gas programs will likely lead to cropped natural gas production, thereby hurting the company’s overall volume level.
Another area of concern for us is the transfer of the high-quality and high-growth enhanced oil recovery and downstream assets (post-split). As a result, the business risk profile of the reorganized Encana is weaker than that of the predecessor company.
Hence, we expect Encana to be at par with the broader industry and other players such as Canadian Natural Resources Ltd. ( CNQ - Analyst Report ) and Talisman Energy Inc. ( TLM - Analyst Report ) . Encana shares currently retain a Zacks #3 Rank, which translates into a short-term Hold rating.
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