Is Chesapeake Crawling Back?

It certainly has been an interesting summer and volatile ride for shareholders in frazzled natural gas giant Chesapeake Energy (NYSE:CHK). The former analysts’ darling has fallen on hard times as a number of internal and external factors have hit it particularly hard.

First, the advanced drilling revolution has caused surging natural gas production across the country. Rising inventories have forced gas prices down to historic lows — and below the marginal cost of production for many wells. Then came Chesapeake’s internal problems, with firm’s finances and inner dealings of CEO Aubrey McClendon.

These included corporate governance issues, secret commodities hedge fund operations and various other backdoor loans made against the firm’s controversial Founder Well Participation Program. Approved by shareholders in 2005, the program granted McClendon a 2.5% stake in each of Chesapeake’s wells until 2015.

All of these issues, plus the firm’s steadily growing debt, were enough to make most shareholders head for the hills. Shares hit a post-recession low of $13.32.

Yet, the gears my finally be turning at the energy firm. Its recent asset sales may keep the debt collectors at bay, and a realignment of the board could signal its return. Since mid-May CHK shares are up around 32%, to $19.75.

Selling the Jewels

Chesapeake recently reported the highest quarterly profit in the company’s history. The reason for the recent outperformance: asset sales. Overall, they managed to boost net income by roughly 91% to $972 million in the quarter.

The biggest was the company’s sale of its entire 45% interest in its midstream subsidiary, now called Access Midstream Partners (NASDAQ:ACMP), to private equity firm Global Infrastructure Partners. Chesapeake managed to net a cool $4.08 billion from the sale. The sale gave GIP access to more than 3,900 miles worth of pipelines and gathering assets fed from strong producers such as France’s Total (NYSE:TOT) and Norway’s Statoil (NYSE:STO). Access Midstream and GIP expect to buy as much as $500 million in assets from Chesapeake every year over the next decade.

At the same time, Chesapeake may have finally found buyers for its prized Permian Basin assets. On Aug. 6, it announced it would sell some of these fields in Texas and New Mexico to private firm EnerVest for an undisclosed price. Chesapeake also announced that it’s negotiating sales of two other packages of Permian Basin assets.

It’s still on the hunt for a buyer for 500,000 acres in Colorado and Wyoming as well as a joint-venture partner in the rich and Mississippi Lime basin. All in all, Chesapeake now expects to earn $7 billion from divestitures by the end of the third quarter and roughly $14 billion by year-end.

Plugging a Hole

These asset sales are a big deal and go a long way toward plugging the firm’s massive debt. According to Chesapeake’s  second-quarter earnings statement, it had $13.3 billion in net debt as of June 30. That’s up from $9.9 billion a year earlier. Ratings service Moody’s recent cut the firm’s credit rating down to Ba2 with a “negative” outlook on concerns about its debt load.

Without the sales, the cash-flow gap will widen to $18.6 billion by the end of 2013 and force Chesapeake to cancel drilling projects and reduce production targets. So, the recent sales are critical to reducing near-term liquidity risk. Already, the bond markets seem pleased with these efforts because its junk bond yields have fallen to 6.48% on average.

By and large, Chesapeake’s asset sales seem to be working and have pleased investors. I suspect the reason has to do with the firm’s size.

Unlike integrated giant BP (NYSE:BP), which is undergoing its own series of divestures, Chesapeake’s smaller size does make it slightly more nimble. Even though it’s the No. 2 natural gas producer in the U.S., Chesapeake still just does one thing: drill for natural gas. There’s no refining operations, deep sea fields, etc. Just natural gas.

Selling off a field here or there still plays into that strict focus and allows the firm to potentially be more flexible — and profitable — when natural gas prices rise again. That’s certainly a plus.

Still Too Risky

The question is whether or not it’ll survive long enough to get there. Turnarounds take of plenty of time. While these asset sales reduce the near-term liquidity problems, many analysts are already looking toward 2013 and 2014. By then Chesapeake will have sold “all of the best stuff they have to offer.” That’s the real long-term problem.

So for now, things seem to be getting better for the beaten-down natural gas producer, and the trends may finally be moving in a positive direction. However, Chesepeake is still subject to a ton of risk. Given that, I’m still not convinced I would want to hold its shares.

As of this writing, Aaron Levitt doesn’t own any securities mentioned here.

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