Volatility, thy name is Chesapeake Energy Corporation (CHK).
Things haven’t exactly been all sunshine and lollipops for CHK over the last couple of years. Problems with its former over-the-top CEO, high debts and sustained lower prices for crude oil and natural gas have basically obliterated the former leading energy stock. All of these issues have caused CHK stock to plunge a whopping 94% since hitting its peak back in June of 2008.
With CHK stock scraping penny stock status, many opportunistic traders and investors looking for value have swooped in on Chesapeake Energy. Each day, CHK seems move — higher or lower — with gusto. As of this writing, it’s dropping 15% on relatively no news.
So what’s up with CHK and should you take the plunge? The answer may not be what some investors want to hear.
The Recent Bounce at CHK
After touching about $1 per share only back in mid-February, bottom fishers in CHK were rewarded in spades last week as Chesapeake Energy jumped about 88%. The reason was several fold.
To start with, oil and natural gas prices rebounded slightly. Obviously, if your profits are determined by the underlying prices for commodities, any bump upwards will do wonders for your bottom line — and CHK needs all the help it can get on this front. Profits and cash flows remain elusive for the natural-gas driller. Operating losses — albeit better than expected — continue to mount despite cuts to CAPEX spending and G&A costs.
That bump in energy prices also means that CHK stock’s heavy debt load could actually be serviced. Debt propelled Chesapeake Energy into the large natural gas driller it is. Any extra cash coming in makes that debt — currently $14.5 billion — much more manageable and helps reduce the bankruptcy risk at the firm. Also helping has been another round of asset sales. During its last earnings release, CHK announced that it has agreed to sell $700 million worth of assets so far in 2016. The firm has another $500 million to $1 billion in targeted sales for the rest of the year.
CHK has used asset sales to “kick the can” and keep itself afloat over the last few years in the lower-price environment. Those sales have helped it reduce its overall debt from the $20 billion-plus it was carrying when former CEO Aubrey McClendon was in charge. So the extra cash here helps reduce bankruptcy risk, yet again.
As for Chesapeake’s former CEO, McClendon was recently indicted on charges of conspiracy relating to price/bid fixing for natural gas wells. The natural gas company gained immunity from criminal charges thanks to a Justice Department program that shields companies if they are first to report antitrust violations. CHK gave up the goods on McClendon and won’t be seeing anything from the case.
Investors seemed pleased with all these things and CHK shares rallied in the process.
McClendon died March 2.
Still Plenty of Bad at CHK
So should investors plow head first in CHK stock?
Not exactly. For starters that bankruptcy risk is still very real.
While debt reduction has occurred, CHK still has a ton of debt left. Energy prices are still not where they need to be for CHK to actually have real operating cash flows.
Operating cash flows — which looks at solely at the money that a firm’s businesses are pulling in before anything else — hit $2.27 billion for all of 2015. That’s about half of what it pulled in for all of 2014.
And let’s not forget that despite the recent bump in energy prices, we are still lower than the average price for all of 2015. Operating cash flows should continue to suffer. Bond investors seem to think bankruptcy is still imminent. CHK’s various debt issues can all be had for around 53 cents on the dollar and 30% plus yields. That’s pretty high yields — even for junk bonds. The bond market is usually pretty spot-on when finding bankruptcy candidates.
Then there is this gem to consider — Analyst Paulo Santos over at Seeking Alpha discovered an interesting “flaw” in CHK’s accounting in which the firm “revised [their] presentation of third-party oil, natural gas and NGL gathering, processing and transportation costs to report the costs as a component of operating expenses in the statements of operations.”
Basically, by moving these into operating expenses, CHK stock is able to record a higher price for natural gas because otherwise — thanks to discount contracts — Chesapeake would be forced to list its natural gas revenue at around $0. It’s an accounting trick to basically make itself look better. CHK in realty is selling gas at near $0 per MMBtu — including some hedges. Santos asserts that the only way to overcome it is to renege on the discount contracts or file for bankruptcy to rid itself of them.
Just Walk Away From CHK
So where does that leave investors looking at CHK? Hopefully, packing up and taking a look at other energy stocks.
Shares of the stock have become a hope trade — rising with every bit of good news. But nothing has marginally changed over the last two weeks. There’s still plenty of debt, natural gas prices remain crazy low and cash flows still stink.
Ultimately, that doesn’t paint a bullish picture for CHK stock.
If CHK does managed to survive this current mess and make it through, investors will have a chance to buy the firm in a much better state later on. Right now, CHK is speculation — pure and simple.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
