Encana Presents Mixed 3Q

Canada’s largest natural gas producer Encana Corporation ( ECA - Analyst Report ) reported mixed third-quarter 2012 results, primarily reflecting better drilling activities at prime areas such as Peace River Arch region, Bighorn and Cutbank Ridge acreages and Piceance Basin. These were partially offset by depressing natural gas picture and higher operating expenses.

The company announced operating earnings per share (excluding one-time items) of 36 cents, beating the Zacks Consensus Estimate of 25 cents. However, comparing year over year, earnings fell 32.1% from 53 cents.

Revenues (net of royalties) came in at $1,025 million, down 56.4% from the prior-year figure of $2,353 million. The result also failed to meet our estimate of $1,432 million.

Production & Prices

Natural gas production declined approximately 13.7% year over year to 2,905 million cubic feet per day (MMcf/d), primarily due to an 11.0% drop in volumes from key resource plays. Encana’s realized natural gas prices during the quarter decreased approximately 2.0% year over year to $4.91 per thousand cubic feet (Mcf).

Meanwhile, the company’s oil and liquids production climbed 24.2% to 30,300 barrels per day (Bbls/d), aided by a 19.2% improvement in output from key resource plays. Encana’s oil and other liquids were sold for $72.17 per barrel, down 12.4% from the third quarter of 2011.

Cash Flows and Drilling Statistics

Encana – which co-partners Apache Corporation ( APA - Analyst Report ) and EOG Resources Inc. ( EOG - Analyst Report ) in the Kitimat liquefied natural gas (LNG) export project – generated cash flows from operations of $913 million or $1.24 per share, as against $1,181 million or $1.60 per share during the September quarter of 2011. The company drilled 188 net wells during the quarter, as against 164 in the prior-year period.

Capital Spending and Balance Sheet

Encana’s capital investments during the quarter were $779 million (excluding acquisitions and divestitures). As of September 30, 2012, Encana had cash on hand of $2,039 million and long-term debt of $7,684 million, representing a debt-to-capitalization ratio of 58.2%.

Guidance

For 2012, Encana expects liquid output to be around 30,000 barrels per day and natural gas volumes to be at 3.0 billion cubic feet per day. The company also targeted to invest about $3.5 billion in capital project during the year.

Recommendation

We are maintaining our long-term Neutral recommendation on Encana. The company 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.

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