If there’s a word that can describe 2017 so far for Chesapeake Energy Corporation (NYSE:CHK), it’s “quiet.” In 2015, it looked like CHK stock might go to zero. Chesapeake Energy spent 2016 frantically reshaping the balance sheet. In contrast, 2017 seems notably devoid of news.
To be sure, oil and natural gas prices have been volatile. West Texas Intermediate oil prices are hitting a year-to-date low as I write this. Natural gas has spiked about 10% off February lows, but remains below 2013-2014 levels.
But for Chesapeake Energy, there’s a sense that the company finally has returned to normal. That’s clearly good for CHK — it means Chesapeake earnings have the potential to move CHK stock higher.
Chesapeake Energy Returns to Normal
It was not all that long ago that it looked like Chesapeake Energy was headed for bankruptcy. CHK stock dipped below $2 in February 2016, but Chesapeake bonds performed even worse. The 2020 6.625% Senior Notes — to use a representative issue — traded as low as 15 cents on the dollar that month.
But Chesapeake has steadily improved its balance sheet over the past year-plus. A flurry of refinancings last year extended debt maturities. Per a recent presentation, Chesapeake now has just $70 million in debt maturing over the next two years.
Asset sales, including an exit from the Barnett Shale in Texas, the divestiture of holdings in the STACK play in Oklahoma and two sales in the Haynesville play, brought in some much-needed cash. Headcount reductions and other cost-cutting efforts also lowered overall opex and the company’s breakeven. Across its assets, natural gas breakeven levels sit in the low $2 range, and oil drilling is profitable at prices above $40, if not slightly lower.
The net result is that CHK now can be judged as a “normal” oil and gas producer, albeit a heavily leveraged one. And that seems to set up CHK stock for a nice run out of earnings.
What to Watch for in CHK Earnings
With near-term balance sheet risk greatly reduced, the focus on Chesapeake Energy earnings likely will turn to the 2017-2018 outlook. CHK has guided for breakeven free cash flow in 2018, a needed step toward refinancing maturities coming due in 2021 and 2022. Analysts certainly will be asking whether that guidance holds as oil continues to slip.
In addition, Chesapeake still has the potential to sell some assets — though its need to do so isn’t as urgent as it was a year ago. But overall, Chesapeake’s first-quarter earnings will be more about operations and production than the balance sheet. And there’s reason to think that bodes well for CHK stock.
Earnings Could Boost Chesapeake Energy Stock
The setup for CHK stock out of earnings looks solid, for a number of reasons. First, it’s unlikely that there will be much, if anything, in the way of bad news on production or cash flow.
According to the April presentation, Chesapeake already has hedged 73% of natural gas production and 68% oil production for 2017 — with the oil hedged just above $50. Additional hedges are in place for 2018 as well. NGL (natural gas liquids) aren’t hedged – and prices there actually have been rising.
Secondly, recent drilling results have been strong, one reason why SunTrust Robinson Humphrey analyst Neal Dingmann upgraded CHK stock this week. Weakness in market prices for oil and gas looks priced in as well, with CHK stock down over 35% from early January highs. That decline has pushed CHK back toward support, which has held repeatedly around $5, not far from the stock’s current price.
More broadly, there’s a sense that the story here has changed, and the negativity that has dogged CHK stock has been banished – at least for the time being. Yes, energy prices are low – but Chesapeake Energy is still standing. And it’s a much better play on a rebound than, say, Exxon Mobil Corporation (NYSE:XOM) or Chevron Corporation (NYSE:CVX).
Both those majors have downstream operations that negate some of the benefits of rising energy prices. In contrast, CHK’s leverage means it will get an amplified boost from higher oil and gas prices.
A Clean Story
Meanwhile, short interest has come down – and bond prices have increased. And the move in bonds makes a bigger difference than CHK stock than one might think.
The aforementioned 2020 issue that traded at 15 cents on the dollar last traded at 101. (Yes, Chesapeake bonds have outperformed the equity off the bottom.) One of the problems with trying to time the bottom in CHK stock last year was that Chesapeake Energy debt was a much better play.
With bonds trading at such a huge discount to par, the debt offered a potential triple – if not more – plus more downside protection if Chesapeake did indeed stumble into bankruptcy.
The competition to CHK stock from Chesapeake Energy bonds largely is gone at this point, as bond prices (mostly) are back near par. And that’s a big tailwind for CHK stock going forward.
It also highlights the change in Chesapeake Energy stock — it now seems like CHK is a “clean” story. If Q1 earnings highlight that fact (and I think they will), CHK stock should gain nicely.
As of this writing, Vince Martin has no positions in any securities mentioned.