The extent to which Chesapeake Energy Corporation (NYSE:CHK) can mount a meaningful recovery in a brutal environment for oil prices is the biggest factor is … well, pretty much up in the air. CHK stock last week fell below $5 per share — an important psychological benchmark for most equities — but has battled its way back above.
Oil prices are down almost 20% since hitting a 2017 closing high of $57.01 in January. Lingering concerns about global oil supplies caused oil prices to fall to their 2017 lows on Tuesday, with West Texas Intermediate (WTI) crude closing at $45.96.
Headwinds in the energy market, which has sent the Energy Select Sector SPDR (ETF) (NYSEARCA:XLE) lower more than 10% this year, has also pressured shares of leading oil majors such as BP plc (ADR) (NYSE:BP), Exxon Mobil Corporation (NYSE:XOM) and Chevron Corporation (NYSE:CVX).
But of course, CHK stock is backed by a much smaller company that’s much more sensitive to energy price movements at this point.
Chesapeake Is Cheap for a Reason
For Chesapeake, however, the natural gas and upstream giant continues to frustrate investors. See, CHK has a strong, recognizable name, and it’s trading at dirt-cheap valuations. But its high debt level — around $9.5 billion — makes Chesapeake highly speculative, unlike Exxon and Chevron.
Not to mention, with oil prices now around $45 per barrel — and with analysts predicting a fall of oil prices to around $35 per barrel — CHK is struggling with a $5 mark that can start to send institutional investors (such as hedge funds and ETFs) out of their investments.
All told, unlike natural gas peers such as Murphy Oil Corporation (NYSE:MUR) or Cheniere Energy, Inc. (NYSEMKT:LNG), Chesapeake Energy is highly reliant on the direction of oil prices. Part of the reason has to do with the fact that the company expects to increase its 2017 capital expenses by almost 30% (midpoint), based on its target spending range of $1.9 billion to $2.5 billion.
And here’s the thing: For Chesapeake’s operating expense blueprint to make sense, it not only needs oil prices to rise above $50 per barrel, but prices must stabilize.
So far, there are no signs that this will happen.
It doesn’t appear as if industry improvement plans by OPEC (Organization of Petroleum Exporting Countries), including talks of production cuts, will immediately change the course. On Thursday of last week, the U.S. Energy Information Administration (EIA) reported that U.S. natural gas stockpiles increased by 78 billion cubic feet for the week ending June 9. Natural gas inventories rose by 106 billion cubic feet in the week ending June 2.
Granted, the 78 billion increase was smaller than the 89 billion cubic feet analysts expected, but the EIA also reported that U.S. natural gas stockpiles totaled about 2.7 trillion cubic feet, which is around 228 billion cubic feet above the five-year average of 2.48 trillion.
In other words, increased stockpiles means lower demand for Chesapeake’s bread-and-butter natural gas business.
Chesapeake Shorts Just Keep Winning
While Chesapeake CEO Robert Lawler has done a decent job managing the company’s cash flow — which has moved to negative territory under former CEO Aubrey McClendon — Lawler should reconsider the company’s plans to increase capital expenditures by almost 30%.
It’s likely for this reason, among others, that short sellers continue to circle CHK stock. While short interest of 18.5% is significantly down from the mid-30s seen earlier in the year, tha’ts still far higher than most of the other stocks on the market.
These short bets have been profitable, too, as Chesapeake Energy’s stock price has fallen more than 27% year to date, falling from $6.92 on Jan. 3 to Friday’s close of $5.10.
And with the company’s plans to increase its oil production this year and into the future, while oil and natural gas prices remain under pressure, the shorts will continue to capitalize on the implied lack of economic sense in the model.
Bottom Line for CHK Stock
Chesapeake is not alone in its energy struggles. And in fairness, the company’s liquidity crisis is not as dire as it was a year ago, thanks to its cost-cutting efforts.
But “less bad” hasn’t helped CHK stock — not when there are better-run and better-capitalized energy names out there like Exxon and Chevron that pay strong yields.
A bet on CHK stock today is a bet on an entire industry improving. And with no guarantees that Chesapeake will be around in the next five to 10 years — unlike Exxon and Chevron, who conceivably could only disappear if the entire oil complex collapsed — CHK will remain under pressure, and likely under $5 per share, until oil prices rise above $50 and stay there.
As of this writing, Richard Saintvilus did not hold a position in any of the aforementioned securities.