Natural gas and upstream giant Chesapeake Energy Corporation (NYSE:CHK) continues to frustrate investors. And it hasn’t helped that when it comes CHK stock, even Wall Street analysts aren’t on the same page with respect to the timing of their calls.
CHK stock closed Wednesday at $5.49, down 2.3% on the week. The shares have fallen some 20% year to date, trailing not only the 5.5% rise in the S&P 500 index and the 10.6% decline in the Energy Select Sector SPDR (ETF) (NYSEARCA:XLE). Aside from falling oil prices, which reached $47 per barrel last week, CHK stock has gotten burned from the company’s high debt level, which is at some $9.5 billion.
Arriving Late to the CHK Stock Bear Party
Last week, Merrill Lynch downgraded Chesapeake to “Underperform” from “Neutral,” which is not a surprise. The call by Merrill Lynch was seen as part of the sector rotation, during which the rating of some prominent names such as Exxon Mobil Corporation (NYSE:XOM) and ConocoPhillips (NYSE:COP) were also changed. But here’s the thing: In the case of Chesapeake, the brokerage giant lowered its price target to $8 from $10.
Now, if you’ve ever wondered when an analyst downgrade is not really a downgrade — if the lowered price target assumes more than a 40% premium to the stock’s current price, it’s tough to consider that call a bearish one. In this case, the lowered price target calls for a 42% premium above Chesapeake’s closing price on Friday. Doug Leggate, the analyst who made the call had this to say:
“We rate Chesapeake as Underperform due to the unfavorable impact of a slower oil recovery. While the company has made significant strides in reducing costs and improving its balance sheet, the company is highly leveraged at weak oil and gas prices. … Our price objective of $8 is based on a five-year outlook which assumes a mid-cycle 5.5 times its DACF multiple and a commodity deck of $68.00 WTI / $3.25 HH. The multiple is based on a finite timeline to delivery, which is supported by core NAV.”
Indeed, Chesapeake is not alone in its energy struggles, but all of what Leggate pointed out was known three-to-six months ago. Yet, the downgrade arrives on the heels of the company reporting strong first-quarter results, beating on both the top and bottom lines thanks to a combination of higher oil equivalent price realizations and lower operating costs.
What Chesapeake Needs to Function
CEO Robert Lawler has done a decent job managing the company’s cash flow, which had moved to negative territory under former CEO Aubrey McClendon. And in fairness, the company’s liquidity crisis is not as dire as it was, say, a year ago. But with natural gas prices still under pressure, CHK still presents tons of risks, unlike peers such as Murphy Oil Corporation (NYSE:MUR) or Cheniere Energy, Inc. (NYSEMKT:LNG), which are not as reliant on higher oil prices.
What’s more, Chesapeake expects to increase its 2017 capital expenses by almost 30% (midpoint), based on its target spending range of $1.9 billion to $2.3 billion. But for its operating blueprint to make sense, the company needs oil prices to rise above $50 and stay there. So far, this hasn’t happened.
Bottom Line for CHK Stock
It has been feast or famine speculating on energy companies, especially names like Chesapeake whose businesses rely heavily on the direction of oil prices.
While Chesapeake has shown some improvements, thanks to its cost-cutting efforts, the company needs too many things to go right for the CHK stock to work.
With respect to the Merrill Lynch downgrade and the implication of the 40% upside, investors should instead focus on the direction of oil prices. Until prices start climbing, energy companies will remain under pressure, especially those like Chesapeake that are hamstrung by debt.
As of this writing, Richard Saintvilus did not hold a position in any of the aforementioned securities.
