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Chesapeake Energy Corporation (CHK) Stock Is a Best Bet on Oil’s Rebound

Back in 2014, oil and gas firm Chesapeake Energy Corporation (NYSE:CHK) sold oil at an average price of $89 per barrel. It sold natural gas at $4.14 per mcf. Today, prices are half what they were and CHK stock is about 20% of the value.

Chesapeake Energy Corporation

The rapid drop in oil and gas prices in late 2015 caught many energy firms flat-footed. Chesapeake was a former high-flier that almost didn’t survive the unanticipated downturn. It was one of the more aggressive acquirers of oil and gas fields in the United States to take advantage of the revolution in hydraulic fracturing, or fracking, for short.

In fact, the firm is one of the pioneers in the fracking technology that has breathed considerable life into the domestic energy industry.

Chesapeake has been in damage control mode since the downturn and should survive. Yet commodity prices remain depressed. Investors will breathe a big sigh of relief if oil prices recover back above $50 per barrel. Ideally prices will rise to $60 per barrel, or higher. The higher, the better for investors in the energy industry, and in CHK stock.

Chesapeake has done an admirable job of scrambling to increase liquidity. Last year, the company issued new debt, retired older debt with higher coupon rates, and retired preferred shares and other debt by issuing shares of its stock at highly depressed levels. Not ideal, but necessary for survival.

CHK management thinks it now has plenty of breathing room until the next industry upturn. Capital expenditures to drill and develop new oilfields have been reduced; initial estimates for this year (2017) were between $1.9 billion and $2.5 billion. Cash flow from operations and debt are covering this necessary spending.

Ample Equity

Presenting at investment bank JPMorgan Chase & Co.‘s (NYSE:JPM) Energy Equity conference last month, Chesapeake highlighted that it has “ample liquidity” above $3 billion, and a revolver where it can tap credit and debt lines for $3.8 billion. Management told investors that asset sales have brought in $350 million so far this year.

Debt reduction remains its “#1 priority”, having paid down $2.6 billion in debt over the past 18 months. Total debt stood at $9.1 billion as of the end of the first quarter. What’s more, it plans to reduce net debt (total debt minus cash on hand to 2x EBITDA (debt to EBITDA is a primary measure to interpret how much debt a company has — 4x-5x is thought to be a worrisome high level).

Back in May, debt-rating firm Moody’s noted that Chesapeake will not generate positive free cash flow this year, or next. But its revolving credit facility should help it bridge the fact that its operations don’t generate enough cash to cover the company’s spending needs. It offered a succinct summary of Chesapeake’s challenges:

“Manageable debt maturities through 2019 and reduced near-term default risk have positioned the company to be able to increase spending, which should allow for production and cash flow growth in the second half of 2017 and beyond. Even with the increase in natural gas prices in 2017 over 2016, the company is challenged to generate adequate returns on capital investment and sufficient cash flow to fund sustaining levels of capital investment; cash flow neutrality is unlikely to occur before the end of 2018. The rating benefits from Chesapeake’s dominant positions in several major North American basins, given the operating and financial flexibility these assets provide.”

Oil Price Random Walk

I am not a big fan of firms that spend more than they make (who is?!). As such, I would usually would run for the hills on a company like Chesapeake. But the valuation is so low that it leaves room for substantial potential upside. And Moody’s alluded to its valuable and enviable energy assets in North America.

Just look at earnings. Analysts collectively estimate 84 cents in earnings this year (2017) and more than $1 next year. That puts the forward P/E ratio at below 6x this year, and below 5x next year. The earnings multiple could easily double with any sustainable recovery in oil and gas prices.

Some have estimated Chesapeake’s proven reserves of oil and natural gas at $80 billion. That is a figure that contemplates currently depressed energy prices and against a market capitalization of $4.3 billion and with $9.1 billion in debt. If oil prices rally, Chesapeake’s earnings could soar, and it would finally have the cash flow and motivation to boost production once again. Obviously, the stock price would also rally significantly, boosting buyout potential, given the appealing oil and gas drilling rights.

Of course, oil prices could remain low or even fall further. In the current downturn oil fell to near $28 a barrel.

Investors (including myself) rack their brains to try and understand the supply and demand relationship for oil, but the reality is prices appear a random walk that can’t be predicted with much accuracy. Just look at how few investors predicted the plummet in prices a couple of years ago.

Bottom Line on CHK Stock

Chesapeake’s predicament is not exactly unique in the industry. The larger blue-chip players, including Exxon Mobil Corporation (NYSE:XOM), Chevron Corporation (NYSE:CVX), and Royal Dutch Shell plc (ADR) (NYSE:RDS.A, NYSE:RDS.B), can’t generate enough cash from their businesses to cover capex spending. They also have to support generous dividend payouts that investors have come to expect.

Chesapeake is unique in that it was too aggressive in the initial build-out and buying of domestic oilfields to take advantage of the fracking revolution. Yet it doesn’t pay a dividend and has appealing assets that could pay off big for investors if/once energy prices rebound.

I’ll hang around hoping for a big rally in the stock price.

As of this writing, Ryan Fuhrmann was long shares of Chesapeake Energy.

Article printed from InvestorPlace Media, https://investorplace.com/2017/07/chesapeake-energy-corporation-chk-stock-is-a-better-bet-on-oils-rebound/.

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