Chesapeake Energy Corporation (NYSE:CHK) has been a go-to favorite for investors thanks to its cheap price. While CHK stock was showing promise throughout the first half of 2017, July and August were not kind to this now sub-$4 stock.
Let’s look at the share price before getting into specifics.
The $4.80 to $5 level served as support, then failed. The same can be said for $4.40, both of which are shown with blue lines on the chart below. The black line has been heavy resistance for CHK stock. Still, shares are oversold and a snap back to $4.40 could be in the cards. While this would represent upside of about 17%, many investors won’t find the risk-reward worthwhile. I’m not sure I do either.
Taking Energy’s Temperature
Click to Enlarge
In other words, crude has every reason to rally, yet can’t seem to clear many hurdles. CHK is also heavily involved in natural gas production. Unfortunately, the commodity hit new 2017 lows earlier this month. Near $2.80, natural gas came within about 30 cents of its 2016 multi-year low.
If these commodity prices fail to move higher, CHK stock will likely struggle to as well, regardless of its fundamental situation (more on that in a minute). Making matters worse, Harvey and its aftermath are forcing CHK to shut down some operations as well. It’s like a double punch to the gut.
Is CHK Stock Viewed Unfairly?
Now considered a penny stock, CHK stock does have a story that’s popular on Wall Street. The energy sector is struggling and CHK stock is no exception. The Energy Select Sector SPDR ETF (NYSEARCA:XLE) fell 5.5% in August and down 13.57% for the year, so far. Others, like Chevron Corporation (NYSE:CVX) and Exxon Mobil Corporation (NYSE:XOM) have seen struggles as well. (Admittedly, though, these three are getting a lift from Harvey).
CHK has stemmed the massive bleeding it once felt on its income statement. Just last quarter, Chesapeake had a significant improvement year-over-year. Revenues grew 40%, while operating income came in at $590 million, up from a disastrous $1.71 billion operating loss in the same quarter in 2016. Importantly, net income came in at $494 million, up from a $1.76 billion net loss.
For the first six months of the year, Chesapeake has earned 86 cents a share. Even with zero EPS for the next two quarters, CHK stock would trade at just 4.4 times earnings. That’s incredibly cheap!
But what’s not impressive? CHK’s balance sheet. On a quarter-to-quarter basis, cash fell from $249 million to just $13 million. Debt increased by $350 million to $9.85 billion. While the rise was less than 4%, it’s still a meaningful number for $3.3 billion company.
Bottom Line for CHK Stock
While CHK may be regaining some of its profitability, its debt is huge and not shrinking fast enough. Yes, total debt is down from $13 billion in the first quarter of 2014, but current levels are still three times the size of CHK’s overall market cap.
If natural gas and oil prices were on the upswing, then it could be reasonable to believe that CHK’s operating cash flow and operating margins would expand. This would come from a combination of lower extraction costs and higher selling prices of these two commodities. In theory, this would allow Chesapeake to become more profitable and generate more cash to pay down debt.
That’s not the case, though. And long-term projections — although they can be inaccurate — have stable, but not overwhelmingly positive news for oil and natural gas. More than likely, prices will slowly but surely wiggle higher, as suggested by Goldman Sachs analysts. CHK stock investors want higher prices sooner, rather than later, given Chesapeake’s current situation.
It’s hard to blame them and easy to see why other investors may choose to pass on this debt-ridden stock. However, Chesapeake is profitable and should it continue to see positive results, shares may react favorable. If one must be involved, keep a stop loss below recent lows near $3.50. CHK stock is a trade, if anything, but hard to call an investment at this point.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
