A couple of years ago, Encana (NYSE: ECA) set out on a journey to reshape its portfolio and focus on assets that could generate high-margin growth at lower oil and gas prices. That strategy is starting to pay off after the company's margins and cash flow soared in 2017. That sets the Canadian shale driller up for even more success in 2018.
Drilling down into the numbers
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Encana's financial results flew higher in the fourth quarter, driven by the company's focus on growing production from its high-margin core assets. Overall, the output from these four resource positions has expanded 31% since the start of the year, as expected, which blew past the original target to increase production from those regions by 20%.
That said, the main drivers of this growth were the company's assets in the Permian Basin of Texas and Montney Shale in western Canada. Output in the Permian, for example, averaged 82,600 barrels of oil equivalent per day (BOE/D) during the fourth quarter, which significantly exceeded the company's original target of 75,000 BOE/D thanks to exceptional drilling results.
Meanwhile, liquids output in the Montney doubled over the course of the year, helped by the addition of several new natural gas processing plants from infrastructure partner Pembina Pipeline (NYSE: PBA). Meanwhile, Encana kept production from both the Eagle Ford in Texas and Durvernay in western Canada flat with 2016, using the free cash flow generated from those regions to fuel growth in the higher-returning Permian and Montney. That helped Encana become a cash-flow machine last year, with it rising 60% versus 2016 to $1.3 billion.
A look at what's ahead
Encana expects to produce even more cash flow this year thanks to the continued growth of higher-margin production. Overall, the company expects total output to jump 18% this year, led by a 24% surge in high-margin liquids. Once again, the Permian and Montney will lead the way, with output in the Permian expected to increase 30% this year, while liquids from the Montney should double again. One factor driving the Montney's fast-growing liquids output is the continued expansion of Pembina Pipeline's system in the region, with it expecting to build two more processing plants there this year. That rising high-margin output should boost cash flow to around $1.9 billion, which would support a similar capex spending level.
With Encana's internally generated cash flow now fully supporting a fast-growing drilling program, and its financial situation continuing to improve, the company has decided to return some of the $719 million of cash sitting on its balance sheet to shareholders. The company built up that cash position by selling assets last year. However, instead of using it to grow faster, it's following industry peers like Suncor Energy (NYSE: SU), which are rewarding investors for their patience during the oil market downturn. In Suncor's case, it announced a 2 billion Canadian dollar ($1.6 billion) share buyback plan last spring due to the strength of its cash flow and had repurchased CA$1.4 billion ($1.1 billion) in stock by the end of the year. Meanwhile, Suncor followed that up by increasing its dividend 12.5% this year and reloaded its buyback with another CA$2 billion thanks to the continued strength of its cash flow. Encana could follow a similar path as Suncor and steadily increase cash returns to investors as its operations start generating free cash flow in the coming years.
The operations have turned, now its time for the stock to follow
Despite turning in a stellar performance in 2017, Encana's stock is down about 14% over the past year. However, that could change in 2018 as the company continues expanding margins and cash flow, with it adding further fuel to that potential recovery by deciding to repurchase its cheaper stock. That move alone could catapult shares in the coming months, much as it has done for Suncor Energy. For perspective, since the Canadian oil giant announced its share buyback plan last spring, shares have risen more than 11% while Encana's stock is only up about 3%. That's why investors might want to consider buying shares of the Canadian shale driller before its turnaround kicks into a higher gear.
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