Chesapeake Energy: There Is More Where That Came From – Seeking Alpha

Chesapeake Energy: There Is More Where That Came From - Seeking Alpha
What Will It Take to Finally Move Chesapeake Energy Stock Higher?
The stock of Chesapeake Energy (CHK) has taken a pause from the recent rally. The exciting merger has now been completed. Plus there are rumors that a major shareholder wants to exit (along with the stock overhang). But this management has brought this company back from the walking dead. The company was headed towards a certain corporate reorganization until this management found a way out of that with the latest merger. That puts this management in a very rarefied talent circle. Shareholders can count on a lot more accomplishments in the future based upon past results. In short, there are a lot more accomplishments on the way as this management works to restore this company to its former glory days.

The stock did take a step back when earnings were announced and the corresponding conference call followed. But that step back was nothing like the pessimism of the merged company prospects back in December.

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If a major shareholder does indeed exit, then this company has the trading liquidity to withstand such a move. That would give readers time to read the latest 10-K and company pronouncements to decide if this stock fits their investment goals. Even major shareholders do not have infinite amounts of shares. So for potential buy and hold investors, this could be a decent entry point to further gains.

Importantly, though, the company has impressed with its earnings per share growth, over three years. Having said that, shareholders may be disappointed with the weak returns over the last three years. So shareholders might not feel great about the fact that CEO pay increased on last year. One might thus conclude that it would be better if the company waited until growth is reflected in the share price, before increasing CEO compensation. Whatever your view on compensation, you might want to check if insiders are buying or selling Chesapeake Energy shares (free trial).

The merger makes a mess of the financial statements for about 3 to 6 months. Despite the best attempts of accountants, the increase in shares outstanding combined with the merger related charges often make the financial statements completely incomprehensible to all but the most advanced and experienced investors.

Shown above is the production upon which the earnings are based. Note that the Brazos Valley (the acquired acreage) only receives credit for about two-thirds of the quarter. On the other hand, the divested Utica Shale assets were present for the full quarter in the previous year. The Brazos Valley production will show steady growth just by receiving a full quarters credit next quarter. This is important because the Brazos Valley production is largely oil. Oil is far more profitable than natural gas production (from the Utica Shale assets sold).

Therefore the cash flow potential will become far more apparent next quarter. Management has already reported considerable well cost progress and increasing well production on the acquired properties. Chesapeake Energy is large enough that the progress made could take a quarter or two to really affect the bottom line. Still, for a merger as large as this one, management appears to be making significant progress quickly.

Part of this has to be due to the long Chesapeake Eagle Ford operating history. These properties are close to ones that Chesapeake was already operating. Therefore the chances of success are greatly improved.

Overall this is a positive result for shareholders, showing that the company has improved in recent years. Its good to see a bit of revenue growth, as this suggests the business is able to grow sustainably. Shareholders might be interested in this free visualization of analyst forecasts.

Note also that the company continues to move rigs from the gassier properties to the more liquids rich properties. The Powder River Basin picked up an additional rig. Combine that with the sale of the Utica Shale properties and the acquisition of the Eagle Ford oil rich properties to conclude that this company has made a big change in strategy towards liquids.

Given the total loss of 38% over three years, many shareholders in Chesapeake Energy Corporation are probably rather dissatisfied, to say the least. So shareholders would probably think the company shouldnt be too generous with CEO compensation.

That strategy change should increase corporate profitability considerably going forward even if oil prices correct from their current levels. Gas pricing has simply become too weak to make decent money at current price levels. The continual shift of rigs towards the liquids based acreage proves that conclusion.

We compared total CEO remuneration at Chesapeake Energy Corporation with the amount paid at companies with a similar market capitalization. Our data suggests that it pays above the median CEO pay within that group.

Basically the company swapped the Utica Shale gas leases for the Eagle Ford oil leases. The market may have been overly concerned with some perceived drops in the financial statements. But any setbacks are likely to be temporary.

Long term debt appears to have remained at about the same level once this swap was completed. Production may have declined, but the all important oil production increased. Plus management has a goal to increase that oil production a lot this fiscal year.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.

Cash flow took a dive in the first quarter compared to last year. But that may have been due more to cutoffs magnifying the oil price decline in the fourth quarter. The recent oil price rally combined with the full quarter inclusion of the new Brazos Valley acreage should materially increase cash flow.

Overall, the first quarter cash flow dropped below a $2 billion annual rate. But most of the rigs are now drilling on acreage that will produce mostly oil and liquids. Depending upon operational results, Chesapeake Energy could easily exit with cash flow running at a $4 billion annual rate. Management still forecasts a sizable increase in liquids production. The continuing cost improvement campaign will also aid cash flow increases.

The largest expense drop was the nearly $1 BOE drop in gathering, processing and transportation expenses. That drop in expenses was led by natural gas liquids which (on a BOE basis) dropped from the $8 range to the $5 range. Much of this BOE improvement was attributed to the sale of the Utica Shale leases. There was also some contract adjustments noted during the quarter. Slowly but surely, some of these inherited and outrageous costs are becoming far more reasonable.

The debt levels remain close to $10 billion. So there is some pressure for the company to increase cash flow considerably. Management appears to have a reasonable strategy for that accomplishment. It would not be unusual, though, for another material sale and potential acquisition to speed the process along. This management has shown considerable discipline in waiting for “the sale price” and making accretive acquisition. Therefore any announcements in this area are likely to be over the long run and not a quick short term fix.

One show of faith in the companys financial progress is the switch from full cost accounting to successful efforts accounting. Note, though, that both accounting treatments can be abused to mislead shareholders about company prospects. The successful efforts method also has the benefit of dispensing with the cost ceiling calculation. This company has had many write-downs due to excessively high book values. So the change could hide still more excessively high book values.

Offsetting that should be a move towards more conservative depreciation rates. Over time, that move should result in conservative asset valuations. In theory, the successful efforts method of accounting is supposed to be more conservative. Time will tell if that is the case with this company.

Management basically reiterated earlier guidance but did take the time to note the changes that would accompany the changes in accounting methods. Mr. Market will need some time to digest the merger and the accounting changes.

The overall increase in liquids production should provide positive earnings comparisons in the future simply because the targeted liquids are more profitable than the gas production. As the merger expenses fade, the positive comparisons should find favor with the market.

There is a risk of a severe sustained oil price decline that could derail the merger benefits and the current guidance. However, that scenario appears unlikely at the current time. Instead it is far more likely that the stock will continue to appreciate from current levels as the continuing good news unfolds. The finances make this investment speculative. But management now has a clear path to investment grade. In short “there is more where that came from!”

Disclosure: I am/we are long CHK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.

It  may seem like the outlook of Chesapeake Energy (NYSE:CHK) stock is becoming more favorable. Oil prices are higher, the early returns from CHK’s recent acquisition are solid, and its last couple of quarterly results have looked decent at worst.

The recent fade of CHK stock only adds to the long-held frustrations of the owners of CHK. Chesapeake Energy stock  has looked attractive for most of the last three years; I’ve recommended it myself on several occasions, while also highlighting the many risks posed by CHK stock.

And Chesapeake Energy stock has made gains from time to time, climbing from $3 to $5+ last year, and doubling off its late December lows in the first part of 2019.

Once again, however, CHK stock hasn’t been able to hold its gains. And it’s worth wondering when, if ever, that will change.

In mid-2014, the shale bubble started to burst, and CHK stock was hammered. It was valued at $30 in mid-2014; in less than two years, CHK traded below $2 as bankruptcy rumors swirled.

Since then, debt has been a big part of the contentions on Chesapeake Energy stock, by both sides. Bears and skeptics argue that CHK is one more oil price downturn away from bankruptcy fears returning. But in any case, the debt continues to weigh on the company and on CHK stock, limiting its ability to be as aggressive as it would like to be.

For bulls, particularly from a valuation standpoint, the debt is a plus. CHK has a market cap of about $4 billion, which combined with that $10 billion in debt gives it an enterprise value of $14 billion. If one values Chesapeake’s business at $1.4 billion, the value of CHK stock would jump 35% to $5.4 billion.

So, fundamentally, the volatility of CHK stock makes some sense. And the recent downturn to $2.44 makes Chesapeake Energy stock more attractive, at least on paper. Another debt refinancing has pushed out maturities, giving the company breathing room. CHK continues to shift toward higher oil production, away from its legacy focus on natural gas, even as optimism toward U.S. shale oil is rising.

CHK’s acquisition of Wildhorse Resource Development seems  to be a solid move, as I wrote when the deal was announced. It provides a larger asset base to back the debt – and more earnings to pay it off. And the company has shifted capital expenditure dollars to the Powder River Basin, where its acreage is performing exceedingly well at the moment.

It seems like Chesapeake Energy itself is making progress. Yet Chesapeake Energy stock, save for the December bounce, isn’t.

There are two broad issues at play when it comes to CHK stock. The first is that even with the recent bounce in oil prices, exploration and production stocks aren’t doing all that well. Chesapeake Energy stock has lost about 28% of its value over the past year; but that performance is about average for its sector . Oil prices have fallen over that stretch, weighing on the sector’s stocks.

The second is that investors’ patience with CHK stock likely is running out. Every Chesapeake earnings report seems to highlight CHK’s potential. But its results simply haven’t improved.

Chesapeake has been targeting positive free cash flow for years, but it hasn’t achieved that goal  and probably won’t this year. CHK has predicted that its adjusted EBITDAX (earnings before interest, taxes, depreciation, amortization, and exploration expense) will come in at $2.55 billion-$2.75 billion. But its interest expense of $500 million-plus and its expected capital expenditures of $2.1-$2.3 billion more than offset that.

Chesapeake has been promising to pay down its debt for years. At the end of 2015, its long-term debt was $10.35 billion. CHK’s debt is now nearly $10 billion, thanks to debt it assumed as part of the Wildhorse deal.

The problem with the company’s  fundamentals, and with CHK stock, is that  on paper, there’s reason for optimism, but in practice, that optimism never seems to last.

On paper, bulls’ contentions make some sense. And one thing CHK stock has proven is that it can bounce, even if those bounces soon fade. Certainly, nimble traders likely have done well with CHK,  and that may be the case going forward as well.

For investors, however, the decision is a little tougher. The acquisition of Anadarko Petroleum (NYSE:APC) by Occidental Petroleum (NYSE:OXY) could lead to more M&A activity in U.S. shale. But Chesapeake, given its huge levels of debt, probably won’t become a takeover target.

Even with Chevron (NYSE:CVX) likely on the prowl after losing out on Anadarko, and majors like Exxon Mobil (NYSE:XOM) potentially looking for shale assets, there are reasons for them to pass on CHK, at least in the near-term. And with the sector’s stock prices still down over the past year, there are other, less-indebted, names that might be worth considering.

I’m personally not ready to abandon my long-term bullishness on CHK stock just yet. But at a certain point, it’s too difficult to keep fighting the tape. CHK stock has become a “show me” stock at this point, and other stocks seem to be better choices right now.

Posted in Chesapeake