Because of its “aggressive production growth targets” and increased debt, which includes the April acquisition of Tom Brown Inc., Moody’s Investors Service lowered the long-term debt ratings on EnCana Corp. (ECA) to “Baa2” from “Baa1.” The outlook on the Calgary-based producer is stable, analysts said Wednesday.

“The company’s tolerance for leverage has risen through a series of actions taken by EnCana that increased debt and reduced equity in the capital structure,” said Moody’s analysts John Diaz and Steven Wood. “In 2003, ECA’s cash flow from operations was $4.3 billion, yet the company spent $5.1 billion in capital expenditures during the year. Also during 2003, ECA returned just over $1 billion to shareholders through the repurchase of 23.8 million common shares and dividends, which was offset somewhat by the issuance of $114 million in common stock primarily through the exercise of employee options.”

The analysts noted that even though a portion of EnCana’s capital expenses and stock buyback were funded with proceeds from asset sales, the net effect from its capital spending and share repurchase increased debt 23% from $5.2 billion at year-end 2002 to $6.4 billion at the end of 2003. “Measured relative to its assets, adjusted debt to proved developed barrel of oil equivalent (PD boe) increased substantially from about $3.40 to $4.80/PD boe during 2003, reflecting both higher debt and lower PD reserves (including the Syncrude sale).”

In April, EnCana announced plans to acquire Denver-based producer Tom Brown in a $2.7 billion all-cash transaction (see Daily GPI, April 16). Moody’s analysts noted that unlike other recent acquisitions by investment-grade exploration and production (E&P) companies that included “some or all equity as part of the total consideration, ECA chose not to use equity. The immediate impact of this decision was to push EnCana’s debt to PD boe over $6, which is substantially higher than the Baa1 peer group.”

EnCana plans to sell more producing properties and expects to raise $1-1.5 billion for debt reduction. However, even though it is “reasonable to assume the company will be successful in this effort, there is an element of execution risk and potential timing delays. Over the near term, taking the asset sales into account, we expect debt/PD boe to be around $5 at the end of 2004 and remain above $4 in 2005, despite a relatively high commodity price environment, which is not consistent with a Baa1 rating.”

EnCana’s leverage, said the analysts, “is exacerbated by its shorter proved producing reserve life, which at 6.2 years is a full year lower than the Baa1 median value of 7.2 years. ECA also has a higher proportion of proved undeveloped reserves, 39%, versus the peer average of 30%.”

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