Thanks to higher oil and gas prices, Chesapeake Energy Corporation (NYSE:CHK) made money in Q2 2017, its second consecutive quarter in the black, putting an artificial floor under CHK stock.
That’s great news for the oil and gas producer, which has lost $19.0 billion in the last two fiscal years — $467 million on an adjusted basis — and it still faces a rather murky future entirely dependent on rising prices to keep it out of Chapter 11.
Chesapeake Energy: How Much of a Risk?
When I last wrote about Chesapeake back in April, I said CHK stock was still a huge risk at $6. Since then, the stock is down 35%.
While its earnings situation is looking far better — Chesapeake Energy generated three times as much revenue in the second quarter year-over-year from less production — it still has a tremendous amount of debt. The company finished the second quarter with net debt of $9.8 billion, 7.7% higher than at the end of December.
In April, Chesapeake had an Altman Z-Score of -2.25 according to GuruFocus.com and -1.97 according to my calculation. Today, I put it at -1.02 while GuruFocus.com puts it at -1.34.
Clearly, it’s making progress but it is still well below 1.81, the minimum Altman Z-Score necessary to be considered out of financial distress.
Current Altman Z-Score Calculation
|
CHK |
|
|
Working Capital |
-911,000,000 |
|
Total Assets |
11,920,000,000 |
|
Retained Earnings |
-16,969,000,000 |
|
EBITDA |
325,000,000 |
|
Market Cap |
3,950,000,000 |
|
Total Liabilities |
12,604,000,000 |
|
Net Sales |
9,331,000,000 |
|
-1.02 |
Sources: SEC.gov, Morningstar
What’s the Better Play on CHK Stock?
Oil and gas prices currently sit at $47.19 and $50.22 per barrel for WTI and Brent respectively and $2.89 per million BTUs. Since we can’t be confident that prices will keep rising, it would make sense for investors wanting to speculate on CHK stock and the price of oil to consider a safer alternative.
“If you’re going for a speculative bet on commodity pricing (and that you understand the risks involved), have at it,” InvestorPlace contributor Josh Enomoto said recently. “But if you’re hoping that Chesapeake Energy becomes the next Exxon Mobil Corporation (NYSE:XOM), that’s going to be a stretch.”
The SPDR S&P Oil & Gas Explore & Prod. (ETF) (NYSEARCA:XOP) is a modified equal-weighted portfolio of 62 oil and gas stocks that tracks the S&P Oil & Gas Exploration & Production Selected Industry Index. It has $2.1 billion in total assets and charges 0.35% annually.
CHK stock has a weighting of 1.82%, which isn’t that bad when you consider the biggest holding, Rice Energy Inc (NYSE:RICE), has a weighting of 2.78% and it is up more than 24% YTD.
Given the poor performance of oil and gas stocks over the past two to three years, it’s not surprising that XOP has been a losing proposition. However, I see it as a more sensible way to play CHK stock at this point in its recovery because XOP’s diversification helps reduce the risk of CHK falling further.
Yes, Chesapeake is starting to string together profitable quarters, but with debt that’s more than twice its market cap, there’s no guarantee Chesapeake will still be trading in 12-24 months.
Unless you can afford to lose 100% of your capital I wouldn’t touch CHK stock despite better earnings the last two-quarters.
Until it strings together a few more quarters of profitability combined with accelerated debt repayment, XOP is a much safer bet.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
