July 31, 2011 in Business

Recent struggles don’t define Encana’s potential for growth

 

Canada’s natural gas specialist Encana (NYSE: ECA) recently failed to ink a lucrative $5.5 billion deal with Chinese petroleum giant PetroChina. But that’s because it knows that it can get a better deal for its Cutback Ridge shale assets in British Columbia.

Big energy companies are predicting an imminent boom in natural gas demand, and many deals have centered on the Canadian oil sands. Encana has been struggling lately, but these problems appear to be temporary. Profitability has been low because of low prices of natural gas. Its financial statements don’t inspire. But that is temporary. Writing off Encana completely would be premature.

In 2010, the company’s proven natural gas reserves increased by approximately 20 percent, totaling 13.3 trillion cubic feet at the end of 2010. However, with 49 percent of them yet to be developed, things do look challenging for the company unless it strikes up one or two joint ventures. It shouldn’t be too difficult to bag a better deal in the near future, though.

Encana’s stock currently looks undervalued, and the company has tremendous potential for growth. It has a long way to go, but this is not a bad time to grab a handful of shares. Once it inks another deal or two and market conditions improve, the stock should start moving up.

Ask the Fool

Q: What does “laddering” CDs involve? Is it a good idea? – O.M., Opelika, Ala.

A: It’s an investing strategy that’s especially attractive if you expect interest rates to rise. Imagine that you want to park $25,000 of your long-term money in CDs, but you’re dismayed by today’s low rates. So instead of dooming your $25,000 to low rates for, say, five years, you can put $5,000 in a one-year CD, $5,000 in a two-year CD, and so on.

Each year one of them will mature and you can reinvest that money in a fresh CD, which may be paying a higher rate by then. This way, you’re not locked into low rates for a long time.

If you’re pretty sure rates will fall over the coming years, consider locking in current rates by buying long-term CDs.

Q: What are “current” and “quick” ratios? – C.J., Richmond, Va.

A: They’re numbers calculated from a company’s balance sheet that give you an idea of the company’s debt levels.

Dividing a company’s current assets by its current liabilities gives you its “current ratio,” which shows whether it has sufficient resources (such as cash and expected payments) to pay its bills over the coming year.

The “quick ratio,” which subtracts inventories from current assets before dividing by current liabilities, is a bit more meaningful.

In both cases, a number above 1 is good, and above 1.5 is better, though a too-high number can reflect unproductive asset hoarding.

Remember that such numbers vary by industry, so compare a company only with its peers - or with itself over time, examining developing trends.

My dumbest investment

I was burned twice, investing in companies that had overstated their income. In both cases, their auditors were from Arthur Andersen. Soon after that, I received several solicitations from an investment newsletter, recommending a rock-solid energy stock. When I researched the company, I found that the auditor was Arthur Andersen, so I walked away. The stock was Enron.

I learned two lessons: Be wary of free advice, and check the auditors. – A.L., via email

The Fool responds: In such cases, it’s more than the auditors who are at fault. Enron fooled many people, Wall Street professionals and employees alike. You’re right to be careful with any investment recommendations, though. It’s best to do your own digging and to look for any red flags, such as deteriorating performance or a regulatory investigation. (Seek green flags, too, such as growth, a healthy balance sheet and competitive advantages.)

The Enron debacle reinforces how important it is to understand how a company is making its money. Enron’s finances were so complicated that most people had no idea what it was really doing.


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