Back in 2014, oil and gas firm Chesapeake Energy Corporation (NYSE:CHK) sold oil at an average price of $89 per barrel. It sold natural gas at $4.14 per mcf. Today, prices are half what they were and CHK stock is about 20% of the value.
The rapid drop in oil and gas prices in late 2015 caught many energy firms flat-footed. Chesapeake was a former high-flier that almost didn’t survive the unanticipated downturn. It was one of the more aggressive acquirers of oil and gas fields in the United States to take advantage of the revolution in hydraulic fracturing, or fracking, for short.
In fact, the firm is one of the pioneers in the fracking technology that has breathed considerable life into the domestic energy industry.
Chesapeake has been in damage control mode since the downturn and should survive. Yet commodity prices remain depressed. Investors will breathe a big sigh of relief if oil prices recover back above $50 per barrel. Ideally prices will rise to $60 per barrel, or higher. The higher, the better for investors in the energy industry, and in CHK stock.
Chesapeake has done an admirable job of scrambling to increase liquidity. Last year, the company issued new debt, retired older debt with higher coupon rates, and retired preferred shares and other debt by issuing shares of its stock at highly depressed levels. Not ideal, but necessary for survival.
CHK management thinks it now has plenty of breathing room until the next industry upturn. Capital expenditures to drill and develop new oilfields have been reduced; initial estimates for this year (2017) were between $1.9 billion and $2.5 billion. Cash flow from operations and debt are covering this necessary spending.
Presenting at investment bank JPMorgan Chase & Co.‘s (NYSE:JPM) Energy Equity conference last month, Chesapeake highlighted that it has “ample liquidity” above $3 billion, and a revolver where it can tap credit and debt lines for $3.8 billion. Management told investors that asset sales have brought in $350 million so far this year.
Debt reduction remains its “#1 priority”, having paid down $2.6 billion in debt over the past 18 months. Total debt stood at $9.1 billion as of the end of the first quarter. What’s more, it plans to reduce net debt (total debt minus cash on hand to 2x EBITDA (debt to EBITDA is a primary measure to interpret how much debt a company has — 4x-5x is thought to be a worrisome high level).
Back in May, debt-rating firm Moody’s noted that Chesapeake will not generate positive free cash flow this year, or next. But its revolving credit facility should help it bridge the fact that its operations don’t generate enough cash to cover the company’s spending needs. It offered a succinct summary of Chesapeake’s challenges:
“Manageable debt maturities through 2019 and reduced near-term default risk have positioned the company to be able to increase spending, which should allow for production and cash flow growth in the second half of 2017 and beyond. Even with the increase in natural gas prices in 2017 over 2016, the company is challenged to generate adequate returns on capital investment and sufficient cash flow to fund sustaining levels of capital investment; cash flow neutrality is unlikely to occur before the end of 2018. The rating benefits from Chesapeake’s dominant positions in several major North American basins, given the operating and financial flexibility these assets provide.”
Oil Price Random Walk
I am not a big fan of firms that spend more than they make (who is?!). As such, I would usually would run for the hills on a company like Chesapeake. But the valuation is so low that it leaves room for substantial potential upside. And Moody’s alluded to its valuable and enviable energy assets in North America.