I thought Chesapeake Energy Corporation (NYSE:CHK) stock looked tempting heading into first-quarter earnings this month — and I turned out to be right. Eventually. CHK stock actually fell 7.4% on the day of its earnings report after opening positive following a headline beat. But CHK would rally the following day, and gain over 10% over the next few sessions.
Coming out of the quarter, I still see potential upside for CHK stock.
There’s plenty of risk, to be sure, between exposure to oil and natural gas prices and $9 billion-plus in debt. Q1 earnings were helped by hedging gains, which won’t necessarily repeat.
But Chesapeake Energy also doesn’t seem to have received enough credit for its heavier natural gas exposure, where prices actually had improved until a recent dip. The balance sheet has strengthened. And increasingly effective drilling techniques should help production going forward. CHK is getting back to normal, and if energy prices help at all, it could get back to $6 and beyond.
Chesapeake Energy Earnings Were Solid
It’s important to note that Chesapeake Energy’s earnings weren’t quite as strong as headline numbers suggested. Hedging gains exceeded $300 million, and represented 22% of total oil, natural gas and natural gas liquids sales in the quarter.
And there were a few concerns in the numbers. The most notable was that capital spend was higher than expected. That creates some concern given Chesapeake’s debt load and still-lingering questions about its ability to deliver.
But overall, the quarter looked strong. Chesapeake Energy raised full-year production guidance, and continues to see a nice lift coming in the second half. (That increase, of course, will be driven in part by the recent investments.) Production in the Haynesville play, once “left for dead”, has returned. New drilling techniques are working and improving both efficiency and volumes.
CHK stock is a long-term play, to be sure. It will take time to get the balance sheet back to targeted leverage levels. But Q1 earnings, at the least, were a step in the right direction.
The Long-Term Case For CHK Stock Still Holds
Coming out of the quarter, the long-term case for CHK stock remains intact. Chesapeake Energy still has a lot of work to do in terms of getting production up, and 2017 seems likely to be a negative year in terms of free cash flow. But the balance sheet has been cleaned up, with maturities extended far enough to give the company some breathing room.
From that standpoint, CHK stock simply hasn’t received enough credit this year. Weakened natural gas and crude prices help explain the 21% decline in Chesapeake Energy year-to-date. But support clearly is holding around $5 — not terribly below current levels — and any bounce in energy prices will turn Chesapeake’s debt into leverage to its equity price.
There’s still the question of when and if additional asset sales will be completed, a notable focus of Wall Street analysts. Those assets could further improve the balance sheet, but at the obvious cost of lost production. But, again, Chesapeake Energy at least has time to make those decisions, instead of needing to engage in a “fire sale” process. And as shale technology continues to improve, per-well metrics should improve in tandem.
CHK Stock Looks Good Below $6
From a cash flow standpoint, Chesapeake Energy still is a 2018 play at the earliest in terms of operating based on generated profits. The company continues to target a 2x leverage ratio by 2020, helped by asset sales.
It’s a story that requires patience, and it requires at least some help from oil and natural gas prices. But it’s also a story that’s working so far. It will take some time, and likely some volatility. But CHK stock still has a clear path to upside from here. And if oil and natural gas prices provide just a bit of help, that upside could be substantial.
Chesapeake Energy’s leverage makes it a much better bet on higher energy prices than, say, Exxon Mobil Corporation (NYSE:XOM), which is too hedged for its own good in a higher-priced environment. But what Q1 shows is that even in the current environment, Chesapeake Energy still has a fighting chance.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.