Canada’s largest natural gas producer Encana Corporation ( ECA - Analyst Report ) reported mixed second quarter 2012 results, primarily reflecting higher liquids volumes and reduced operating costs, partially offset by lower price realizations.

The company announced operating earnings per share (excluding one-time items) of 27 cents, beating the Zacks Consensus Estimate of 19 cents. However, comparing year over year, earnings fell 43.8% from 48 cents.

Revenues (net of royalties) came in at $731 million, down 63.2% from the prior-year figure of $1,986 million. The result also failed to meet our estimate of $1,404 million.

Production & Prices

Natural gas production declined approximately 15.3% year over year to 2,802 million cubic feet per day (MMcf/d), primarily due to a 15.9% drop in volumes from key resource plays. Encana’s realized natural gas prices during the quarter decreased approximately 5.9% year over year to $4.79 per thousand cubic feet (Mcf).

Meanwhile, the company’s oil and liquids production climbed 16.7% to 28,000 barrels per day (Bbls/d), aided by a 7.0% improvement in output from key resource plays. Encana’s oil and other liquids were sold for $80.32 per barrel, down 13.3% from the second quarter of 2011.

Cash Flows and Drilling Statistics

Encana – North America’s second largest producer of natural gas, behind Exxon Mobil Corporation ( XOM - Analyst Report ) – generated cash flows from operations of $794 million or $1.08 per share, as against $1,089 million or $1.48 per share during the June quarter of 2011. The company drilled 85 net wells during the quarter, as against 145 in the prior-year period.

Capital Spending and Balance Sheet

Encana’s capital investments during the quarter were $797 million (excluding acquisitions and divestitures). As of June 30, 2012, Encana had cash on hand of $1,874 million and long-term debt of $7,657 million, representing a debt-to-capitalization ratio of 52.8%.

Guidance

For 2012, Encana expects liquid output to be around 30,000 barrels per day, up 7% from the earlier projection. The company also targets to invest an additional $600 million in capital project during the second half of 2012.

Encana expects this increased investment to generate average daily liquid production of 60,000 barrels to 70,000 barrels per day.

Rating & Recommendation

We are maintaining our long-term Neutral recommendation on Encana, supported by a Zacks #3 Rank (short-term Hold rating).

Encana possesses a high-quality, low-cost asset base in some of the best gas plays in Canada and the U.S. Mature plays with stable production, such as Jonah and Greater Sierra, nicely complement the company’s high potential growth areas such as Haynesville, Montney and Horn River. We also appreciate Encana’s disciplined approach toward capital investment and project execution.

However, the current unfavorable macro backdrop is expected to continue to offset the positives, at least in the near term. The growing popularity of renewable sources of energy, challenging market prices and cost inflation are other major areas of concern.