Investors who bought into Chesapeake Energy Corporation (NYSE:CHK) a year ago are sitting on a whopping 37.3% return. Heck, if you bought CHK stock at the beginning of 2016, you made 56% on the year, more than four times the S&P 500.
CHK stock hasn’t traded below $5 on a consistent basis since July 2016. Suddenly, it has become the poster child for low volatility. Trading as high as $30 less than three years ago, Chesapeake Energy longs probably feel a bottom is in — and who could blame them?
CHK stock appears ready to crack double digits once energy prices push higher or other good news appears as a catalyst to get it moving. InvestorPlace contributor Vince Martin feels an improving economy should help with that.
“The economy is improving, which generally drives energy prices higher,” Martin recently wrote. “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.”
It’s hard to argue with economics or Martin’s assessment.
So CHK Stock Is a Winner?
There’s a caveat.
Rising energy prices float all boats; investors still need to evaluate the risk of buying CHK stock (instead of buying another oil and gas stock) and its $9.9 billion in long-term debt. Anytime a company’s outstanding loans are greater than its market cap, you’re most certainly playing with fire.
Having said all this, let me just say that I’m by no means an expert when it comes to oil and gas stocks. I did, however, warn investors back in 2011 when CHK stock was trading above $30 that it was going nowhere fast and to steer clear of it. Of course, in hindsight, we know what happened.
The one thing I’ve learned from all my years writing about stocks is that you get pretty good at knowing your strengths — and weaknesses. For me, energy stocks are my kryptonite. Just reading the word BBOe gets me tied up in knots.
I’m sure some investors have figured out down to the penny how much Chesapeake Energy’s 1.7 billion barrels of oil equivalent are worth. Maybe $40, $50, $60, all the way up to $100 per barrel — and I’m sure their calculation suggests CHK stock’s intrinsic value is worth far more than $6 per share.
Good on them.
For the rest of us left to our own devices it’s important that we carefully evaluate the risk of buying CHK stock, given that it could still go bankrupt.
If you believe that energy prices will rise from their current levels around $53 to, say, $70, a lot of businesses will benefit from this increase, not just Chesapeake Energy. And the other side of this argument is … what if oil prices don’t rise? Goldman Sachs Group Inc (NYSE:GS) sees oil prices stabilizing over the long term, settling in the mid-$50s.
Either way, why wouldn’t you just buy an oil-related exchange-traded fund to minimize your risk that CHK isn’t the one?
Chesapeake Energy’s Financial Situation
Now, let’s get back to Chesapeake Energy potentially going bankrupt.
GuruFocus.com says Chesapeake Energy’s Altman Z-Score is currently -2.25. Anything less than 1.81 suggests a company faces the real possibility of bankruptcy within the next two years. Of course, that can change dramatically by making money. Analysts estimate that CHK will make 74 cents and $1.18 in fiscal 2017 and 2018 respectively.
I did a quick Altman Z-Score calculation of my own which appears below.
Current Altman Z-Score Calculation
Source: Morningstar.com Financials
I get -1.97 which is slightly better than GuruFocus.com. If you make the EBITDA loss of $3.06 billion, positive, the Altman Z-Score becomes -0.42, still in bankruptcy territory but clearly much better. The improved earnings situation would then increase the value of its assets, which would push the number closer to positive territory.
So, yes, it’s very possible that two years of increased earnings will significantly reduce the risk of bankruptcy.
My brand of investing is simple. Follow Warren Buffett’s lead. Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.
Back in 2011, I suggested EOG Resources Inc (NYSE:EOG) provided less risk to investors than CHK. Clearly, that hasn’t changed.
At $6, CHK stock is still a huge risk.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.