It’s no secret that Chesapeake Energy Corporation (CHK) has been suffering under the weight of its enormous debts.
That debt — which was incurred as it rose to prominence — seemed manageable when natural gas prices were high. But with prices for crude oil and natural gas crumbling over the last few years, that debt has become a huge yoke around its neck.
And shares of CHK have fallen like crazy.
But in recent weeks, Chesapeake has rallied. Since bottoming out at a close of $1.59 back in February, shares have gained a whopping 276%.
But did investors perhaps get ahead of themselves?
With Chesapeake Energy about to report first-quarter earnings, investors certainly are looking for some spectacular numbers and major improvements to their debt situation. The question is whether or not CHK earnings will actually deliver the goods.
Another Loss for Chesapeake Numbers on the Surface
As with much of the energy sector, CHK isn’t exactly going to hit it out the park this quarter.
Energy prices were still in the proverbial toilet during the first three months of the year. And as expected, that’s hitting even the biggest and most top-notch energy stocks — like Exxon Mobil Corporation (XOM) — in the pocket book. So for a struggling firm like CHK it’s still not going to be pretty.
Analysts expect the natural gas driller to lose around 10 cents per share in adjusted earnings as well as see sinking revenue. Last year at this time, CHK was at least profitable on an adjusted basis.
But investors shouldn’t focus directly on the loss itself. Perhaps it’s only skin deep.
True, losing money does hurt. But that loss per share is actually a sequential improvement over the last quarter. Last quarter, CHK managed to lose 16 cents per share. The key is what Chesapeake has been doing to improve its stature in the oil patch.
For starters, CHK has been plowing head first into a number of cost-control measures. CAPEX spending is basically gone as it has reduced its spending plan in 2016 by 57%. Much of that cost has been in well completions. Basically, Chesapeake is still drilling, as oil service fees have plunged. But the firm isn’t turning on the spigot of these wells just yet. That’ll allow it save on costs until natural gas and crude oil prices rise.
Secondly, management has determined that the best use of the reduced CAPEX should go into the most profitable areas of production. For CHK, that means digging into low-cost Eagle Ford and Haynesville Shales. The well dynamics continue to be favorable here and by tapping more wells in these areas, Chesapeake should be able to reduce its costs.
Chesapeake has also continued to reduce costs by announcing layoffs, restructuring its remaining gathering/midstream assets and continuing to sell now non-core assets. CHK has also taken the painful steps in cutting its dividend payments.
Over the summer, it suspended the dividend on its common shares. However, at the beginning of the year, CHK announced that it would suspend dividend payments on its various preferred shares. Both of these measures will help it save much needed cash.
Focus on Debt at CHK
All of this cost cutting, slightly better earnings and asset sales come down to one thing — reducing debt at CHK. If it wasn’t for that high debt, Chesapeake probably wouldn’t be suffering as much.
For investors, the key for CHK earnings comes down to whether or not these cost-control measures have resulted in a meaningful reduction of CHK’s high debts.
So far, those moves have been paying off. Back in February, CHK managed to pay off nearly $500 million in debt after asset sales came in better than expected. The firm has also been planning ahead by snagging up discounted debt of longer maturities. Chesapeake recently announced that it was snagging up bonds that mature in 2017 for nearly 45% off face value.
For the quarter, CHK should finally begin to see meaningful reduction in debts.
CHK Still Risky, But Getting Better
Will Chesapeake be a winner this earnings season? Most likely. The firm should be able to deliver on cost controls designed to improve cash flows. Those controls should help offset some of the reduction in energy prices realized over the last three months.
The real thing will be if the extra cash has made a real dent in CHK’s heavy debt load. That’s exactly what investor need to hear. That debt has been a real issue for CHK. Reducing and freeing itself from that burden is ultimately what is needed at the struggling natural gas producer.
So is CHK stock a buy a head of earnings? I’m inclined to still say no. The huge run-up since the bottoming of shares is already pricing in a big-time debt reduction in the works. There is still plenty of risk in CHK stock and a lot could still go wrong for the firm.
But things are improving and hopefully, CHK will deliver some sort of improvement with its latest earnings release.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.