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Bet on Chesapeake Energy Corporation (CHK) Stock as Energy Rallies

I’ll admit it: I didn’t think Chesapeake Energy Corporation (NYSE:CHK) was going to make it. With the company badly overextended just ahead of a huge collapse in oil prices, bankruptcy was a very real — and near-term — risk in early 2016.

Bet on Chesapeake Energy Corporation (CHK) Stock as Energy Rallies

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CHK stock fell under $2 in February 2016 — a price that at the time that didn’t appear at all unreasonable.

A nearly 40% decline on Feb. 8, 2016 was sparked by rumors that Chesapeake Energy was preparing to restructure its debt. That move could have wiped out CHK stock.

The narrative surrounding CHK stock and Chesapeake Energy is very different at the moment. Short interest in CHK stock has come down markedly (though it remains among the highest for S&P 500 stocks). Chesapeake Energy has pushed out debt maturities, nearly eliminating any near-term bankruptcy risk.

Costs are coming down, and earnings should rise. Even though CHK trades well below its early decade highs, there is a sense of normalcy surrounding the stock for the first time in a few years. And that should allow CHK to rise.

Why CHK Stock Is a High-Risk Buy

Even with bankruptcy perhaps not on the immediate horizon, CHK stock is a risky play. Debt remains a concern: Chesapeake had nearly $10 billion in long-term debt as of the end of 2016. That leverage combined with the natural leverage of oil and gas exploration makes CHK stock inherently volatile.

But Chesapeake Energy has at least managed to move its debt maturities out to the next decade, limiting the possibility of a near-term bankruptcy. New drilling techniques are lowering costs. And energy prices have at least stabilized, allowing Chesapeake to better match costs and revenue.

Meanwhile, analysts are expecting a swing back to earnings in 2017 and 2018. The company has guided for production to increase starting in the second half of this year. Acreage in the Powder River Basin has shown strong early results.

Chesapeake still has extensive operations in the Eagle Ford play in Texas as well. That play has been targeted by majors including ConocoPhillips (NYSE:COP), and highlighted as a growth play by Sanchez Energy Corp (NYSE:SN) and EOG Resources Inc (NYSE:EOG), among others.

Meanwhile, improved drilling techniques are lowering costs as well. Longer “laterals” lower well costs and increase production. The combination of strong acreage and better drilling means production is set to scale on a multi-year basis.

And with investors no longer focusing so intently on balance sheet transactions, it seems likely that at some point, that increasing production will help CHK stock.

Chesapeake Energy Needs Some Help From the Markets

Still, it’s tough to see big upside from current levels without some help from the oil and natural gas markets. While CHK is more gas-heavy in terms of production, higher crude prices will help earnings and cash flow as well.

A retreat to sub-$40 oil and ~$2 natural gas probably doesn’t bring CHK stock to its knees, as would have happened a year ago. The push-out in debt maturities has given Chesapeake Energy enough time to wait out a short-term period of lower energy prices. It also likely means CHK stock does decline, at least in the near term.

Of course, the converse is true as well: higher energy prices provide nearly free cash flow to Chesapeake Energy, at least in 2018 and beyond. (Much of the company’s 2017 production is hedged.)

And that makes CHK stock attractive for investors looking to play higher oil and gas. Unlike, say, Exxon Mobil Corporation (NYSE:XOM), which is a surprisingly poor play on higher oil prices, in particular, CHK stock should provide leveraged returns on any upside moves in both oil and natural gas.

Will CHK Stock Rise?

Will those moves come? It seems likely they will, at some point. The economy is improving, which generally drives energy prices higher. President Trump’s expressed desire for higher coal production should have less practical impact than he expects, as utilities already have switched to natural gas – and aren’t switching back. I don’t know that I expect $70 oil and $4 natural gas again – but there is room for higher energy prices in the current economic climate.

And CHK is one of the better plays on those prices, given its financial leverage and given its acreage in the Powder River Basin and the Eagle Ford. It’s a high-risk play, to be sure – but that’s the nature of the oil and gas space. At least Chesapeake Energy offers substantial reward for its risk. And it has enough going for it to make CHK stock a buy.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

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