Should You Buy Chesapeake Energy Corporation (CHK) Stock? 3 Pros, 3 Cons

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Chesapeake Energy Corporation (NYSE:CHK) survived death. A year ago, the market believed CHK stock was quite likely to end up worthless, at one point sending it down 28% during a day when bankruptcy rumors were raging. Higher oil and gas prices and timely management decisions saved the firm, however. And the stock reacted, with Cheasapeake Energy flying up from $2 back up to as high as $8.

Should You Buy Chesapeake Energy Corporation (CHK) Stock? 3 Pros, 3 Cons

Since then, however, things have started heading south again. Shares are off 25% year-to-date. Falling oil prices and a generally uncooperative winter for natural gas hurt sentiment.

And the company’s balance sheet, while much-improved, remains debt-laden. Can CHK stock double again and get back to the double digits? Insiders are betting yes, but institutions are bailing on the firm.

Let’s take a look at both perspectives.

CHK Stock Cons

Energy Prices Fading: There were many people, myself included, who thought Chesapeake Energy had a real chance of going bankrupt in 2016. This obviously didn’t happen. The savior? Higher oil and natural gas prices. The price of oil as much as doubled off its January 2016 low, and natural gas surged from the mid-$1’s up to as high as $4 recently.

However, the rise in energy prices seems to have moved into reverse. Oil has slumped in recent days. Investors had taken record long positions in oil futures, and appear to have gotten caught on the wrong side of that bet.

The latest news, that Saudi Arabia isn’t delivering as much on production cuts as hoped has added to the selling. Meanwhile, natural gas has retreated from $4 to the high $2’s recently. Some of this is seasonal, but the weather also hasn’t helped matters either. Yes, there was a blizzard last week, but it’s a little late with earlier warm weather more than offsetting the late arctic blast.

Big Holders Selling: Two big owners of CHK stock have unloaded stakes recently. Famed activist investor Carl Icahn previously held a huge stake in Chesapeake, owning 9.4% of the company. Last fall, he sold more than half of his position, supposedly for tax planning purposes. And in November, he dumped the rest of his CHK stock.

Apart from Vanguard, which as a passive asset manager isn’t much of a vote of confidence, that left Southeastern Asset Management as the biggest CHK stock holder. It had previously owned 10.6% of Chesapeake’s stock. However, its most recent filing showed that Southeastern had slashed its position and now owns just 5.7% of the company. While insiders are buying, which is good, institutions are dumping.

Still a Long Road to Profitability: Yes, according to how management defines cash flow neutral, they should get there by 2018. But there’s still a lot of doubt about when CHK common stock will do much for its owners. While the company has avoided bankruptcy and kept the common stock alive, it’s unlikely to show meaningful profitability for years, barring a huge run in oil or gas.

Witness the recent announcement that Chesapeake is restoring payments on its preferred dividends. This is a positive, it shows management is more confident about its cash position. Since the preferred stock is cumulative, the foregone preferred dividends did have to be paid sooner or later.

However, the company is unlikely to be cash flow positive once accounting for debt service and preferred stock payouts. And even that is less than generating an actual accounting profit, which includes depreciation and other such non-cash charges. Long story short, CHK common stock probably won’t show meaningfully positive earnings-per-share or pay a dividend for years to come.

CHK Stock Pros

Insider Buying: However, it’s not all bad news on the big investor front. Insiders are buying Chesapeake stock. Director Archie Dunham in particular still wants more CHK. He picked up another 500,000 shares last week at $5.32. Now before you rush out to follow him, consider that Dunham has bought CHK stock aggressively for years. In one ill-timed move, he bought 500k shares up at $23.32 per share. In total, since 2012, he has purchased more than 4 million shares at a $13 average.

Clearly just buying whenever Dunham does isn’t a perfect strategy. But there’s still something to be said for him having the nerve to buy more. Whether it’s just averaging down or conviction that the tide has turned, the fact that Dunham is still buying 500,000 per share of CHK speaks loudly. And he wasn’t the only insider buying recently. Another Chesapeake director, Thomas Ryan, has picked up another 100,000 shares, including a 50,000 CHK buy earlier in March.

Turnaround Is Well Under Way: It isn’t just higher energy prices powering Chesapeake Energy’s recovery. The company has made real progress improving its balance sheet and forward prospects. The company issued new debt late last year, greatly improving the company’s fiscal situation and liquidity profile. On top of that, asset sales have further reduced the threat of a squeeze on CHK’s cash position.

While the company is still not cash flow neutral quite yet, it seems like a realistic goal by 2018 if energy prices do their part. Chesapeake Energy has now arrived at a position where it can start to grow the business again. SunTrust Robinson Humphrey’s analyst Neal Dingmann suggested that the company can now grow at a 5% to 15% rate annually out to 2020.

Short Squeeze Potential: Many speculators have placed big bets against CHK stock. It made sense last year, with the real risk of imminent bankruptcy. But now that this risk has passed, short sellers may have overstayed their welcome.

As of Feb. 28, short sellers maintained a gigantic 135 million share position against the company, representing 34% of CHK’s stock. Remarkably enough, this figure is actually continuing to rise. Short interest had declined to 102 million shares in December, but has increased with every subsequent two-week reporting period since then. The many short sellers involved in the stock creates serious squeeze potential; in the event of positive news, it’d be impossible for all those betting against CHK stock to get out at the same time.

Bottom Line on Chesapeake Energy

CHK stock finds itself in a much healthier position than last year. Management’s actions, combined with higher gas prices, have cleaned up the balance sheet. Cash flow neutrality, by one definition or another, is coming soon. And as a trading vehicle, CHK could surge if a positive catalyst causes short sellers to flee. As an investment, however, Chesapeake Energy is a dicey proposition. The company is unlikely to be meaningfully profitable or pay a dividend for quite a few years.

Yes, the assets have value, but how much? Chesapeake never produced all that much operating profit even during the better energy price years, and there is still a mountain of debt to service before CHK stock owners get anything. For now, Chesapeake Energy may be worth a trade, but that’s it.

At the time of this writing, Ian Bezek did not hold a position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2017/03/chesapeake-energy-corporation-chk-stock-3-pros-3-cons/.

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