I keep reading the tea leaves for an investment advantage on embattled oil and gas driller Chesapeake Energy Corporation (NYSE:CHK). Company financial filings, investor relations reports, analyst reports, and even online other writers’ investment blogs — anything to discern the direction of CHK stock.
My conclusion from my latest round of analysis is simply this: Chesapeake’s best chances at survival will come from a sustainable rally in oil prices.
I wish it were more sophisticated, but that is really the extent of what it will take for the share price to move higher. And it’s not just CHK. The blue chip giants in the space, including Exxon Mobil Corporation (NYSE:XOM), Chevron Corporation (NYSE:CVX) and Royal Dutch Shell plc (ADR) (NYSE:RDS.A, NYSE:RDS.B) are operating only at cash-flow break-even because of low oil prices.
Chesapeake is in a much more precarious position than the integrated energy titans. It’s a much smaller firm and also a bona fide wheeler-dealer in the industry. Every year it invests billions in developing its oil fields and buying new ones. Looking at its cash flow statement over the past decade and it becomes clear that it has simultaneously also sold billions of oilfield and energy assets in most of the last 10 years.
The same goes for debt issuance and pay down.
Back in 2012, Chesapeake flipped nearly all of its debt, issuing $27 billion while repaying nearly $26 billion that same year. In 2016, that figure was closer to $8 billion (both pay down and issuance), And fortunately this year, it sold more oil and gas assets than it spent to either acquire or work on its existing ones (investments in property, plant, and equipment on the cash flow statement).
CHK has a solid track record of balancing investment with divestment to hold the best oilfield assets out there.
All the wheeling and dealing gives me some comfort that management is adept at securing enough capital to operate its vast network of oil and gas properties. This includes assets in the Powder River Basin, Appalachia, and Mid-Continent regions. Collectively the company owns “interests in approximately 22,700 oil and natural gas wells and produced an average of approximately 575 million barrels of oil equivalent per day (mboe/d) in the 2016 fourth quarter, net to our interest,” according to its February 23 8-K filing.
As of the end of last year, the company estimated proved reserves of 1.708 bboe (One bboe equals one billion barrels of oil equivalent). The only estimate I’ve seen to spell out the value of this vast reserve base is in Marketwatch which estimated Chesapeake’s proven reserves of oil and natural gas at $80 billion. That is quite a bit above the current market capitalization of $4.4 billion.
Current debt currently stands at $10 billion for an enterprise value just shy of $15 billion — the estimated total value of the company.
There have been concerns that CHK will not be able to stay in business because of low oil prices and its hefty debt load. The major debt ratings agencies have lowered its credit rating substantially since late 2015, which coincided with a precipitous drop in oil prices.
This concern is certainly valid. Due to its more precarious financial position, Chesapeake has had to post collateral to enter in to certain processing, transportation, or hedging agreements. It has also had to amend and modify certain other credit facilities.
Not exactly a vote of confidence on its financial stability.
Could CHK Stock Rally?
This all sounds a bit complicated when you think about it, but Chesapeake could recover significantly, if and when oil prices rise a bit. On average, analysts already project 78 cents in earnings per share this year, and as much as $1 for all of 2018. Applying a market multiple on those earnings suggests a share price that could triple from existing levels.
Management is planning to break even on a cash flow basis by the end of 2018. It has paid down debt aggressively since oil prices plummeted, and also cut capital spending to “just” a couple of billion dollars annually. And again, it appears to be able to sell oil and gas assets when needed. The same goes for issuing debt.
CHK stock remains one of my more speculative investments and is my main bet that oil prices rally at some point. Who knows exactly when that might be, and most industry players will see share price gains as a result.
Given that Chesapeake has historically been one of the most aggressive industry players, it is fair for me to assume that it could rally strongly on an upturn. And, it would likely turn quite aggressive in boosting production to take advantage of higher oil prices, which would in turn boost earnings. I’m not sure what would happen to cash flow, but it certainly wouldn’t hurt the firm’s financial position.
As of this writing, Ryan Fuhrmann was long shares of Chesapeake Energy.