For Chesapeake Energy Corporation (CHK), its woes are pretty well known at this point. High debts accumulated during the good times are starting to take its toll during the bad times.
It’s a yarn that’s being spun across the energy patch from shale field to shale field. And with the annual spring redetermination season underway, much of the energy sector will hurt even more.
But after a bold deal, CHK somehow managed to keep the spigot of capital flowing. That’s great news (at least in the near term), and removes bankruptcy risk from the table for now. Before you go crazy for Chesapeake Energy stock, however, know that the company isn’t out of the woods just yet.
All in all, CHK stock may very well still be a trade rather than investment.
CHK Gets to Kick the Can
Spring redetermination season is basically when all the banks determine just how much capital to provide exploration and production companies under their revolving credit facilities. Over the last few years, banks have all been willing to raise those credit limits pretty high; but with oil and natural gas dropping, this redetermination period is expected to be poor and met with plenty of credit line decreases. And for the most part, it has been so far.
But being one of the nation’s largest driller of natural gas does have some perks, as Chesapeake was able to pull off one heck of a deal to keep the cash flowing.
Chesapeake’s $4 billion credit facility provides enough cash for it to continue drilling and operating. CHK had blown through much of its cash on hand even after asset sales, so the continued availability of credit is huge (even more so considering just how much the big banks have cut credit liens during redetermination season). Others haven’t been so lucky: Bill Barrett Corporation (BBG) saw its borrowing base drop by 11%, while EV Energy Partners, L.P. (EVEP) saw its credit line sink by 28%.
Perhaps the biggest help to Chesapeake was its ability to get some leniency on the covenants surrounding this debt. Chesapeake’s lenders agreed to temporarily relieve its senior secured leverage ratio by suspending it until September of next year. The lenders also reduced the company’s interest coverage ratio to 0.65 times (from the current 1.1 times) through next March, agreeing to push back CHK’s next redetermination until June 2017, rather than October of this year. CHK will also be allowed to incur up to $2.5 billion in new first-lien debt.
All of this is great news for struggling Chesapeake Energy, allowing the company to (hopefully) ride out the current downturn in oil and gas prices. It certainly takes the short-term fear of bankruptcy off the table and provides much-needed financing to help keep the lights on.
Chesapeake Energy Sold Its Soul
Investors were certainly pleased with the announcement, sending CHK shares up more than 15% on the news. But before you “spud your well” on Chesapeake, there are some big glaring negatives that need to be considered.
Namely, the amount of collateral it was forced to pledge. Chesapeake pledged a lot to get its hands on that money. We’re talking “substantially all” of the company’s assets.
That includes deeds encumbering 90% of all of the company’s proved oil and gas properties, all of its hedge/derivative contracts and company property like real estate assets, corporate jets and even firms fax machine.
The problem here is that any potential slipups or unforeseen issues means that CHK stock is done. It’ll all go to the lenders. What’s more, by pledging 90% of its wells, CHK limits itself on just what it can sell in a bad situation. Asset sales have kind of been CHK’s main source of useable cash over the last few years.
While the credit facility could be tapped instead, it’s still not a great solution. After all, adding on debt is what got CHK into trouble in the first place. Considering that the company bled about $40 million a day in 2015, paying back that facility could be an issue.
And speaking of that debt, CHK must maintain at least $500 million in liquidity at all times. That jumps up to $750 million under the terms of the deal if its collateral ratio falls below 1.1. Basically, if the value of the pledged oil/gas wells fall, which could seriously happen given the output profiles of Saudi Arabia and others.
A Mixed Bag for CHK
All in all, the deal helps CHK stay alive to fight another day. But fighting isn’t exactly thriving. There’s still plenty of operational issues and the new “lower for longer” price environment to contend with. Let’s not forget that tapping the credit facility comes with its own set of headaches, especially if Chesapeake can’t really pay it back.
So is Chesapeake Energy going to file for bankruptcy? Most likely not at this point. The extra $4 billion in credit allows it to kick the can. The question is whether it can kick it far enough to get to the point where oil/natural gas prices recover and it can actually start making money.
That uncertainty doesn’t exactly make CHK stock a screaming buy, but a trade could certainly be warranted.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
