Chesapeake Energy Corporation (NYSE:CHK) CEO Doug Lawler spoke Sept. 5 at the Barclays PLC (ADR) (NYSE:BCS) CEO Energy-Power Conference in New York City. His comments, brimming with the confidence necessary when selling a seemingly impossible dream, focused on the job Chesapeake Energy has done generating free cash flow in recent quarters.
At less than $4, Chesapeake Energy Corporation stock could finally be a buy, at least if free cash flow neutrality is the criterion by which investors judge its turnaround.
Is it enough? Let’s have a look at its most profitable year (2007) in the past decade to get an idea.
Operating and Gross Margins Through the Roof
The last time Chesapeake Energy had an operating profit was 2014 when it made $1.9 billion on $23.1 billion in revenue for operating and gross margins of 29.6% and 15.0% respectively.
By comparison, its best year in the past decade regarding margins was 2007, when Chesapeake generated $2.6 billion in operating profits on $7.8 billion in revenue for operating and gross margins of 34.0% and 62.6% respectively.
2007 was the gold standard regarding profitability where it made $700 million more from less than one-third the revenue. How it gets back to those days is the million-dollar question.
Certainly, higher oil and gas prices help.
In 2007, Chesapeake sold a barrel of oil at an average price of $68.64 and natural gas at $6.29 per mcf. In 2014, a barrel of oil was considerably higher at $87.13, but natural gas was $2.54 per mcf or about 60% lower than in 2007.
Flash forward to 2016, when revenues were almost identical to 2007, and you get an entirely different picture.
Chesapeake spent $4.8 billion on marketing, gathering, and compression in 2016; in 2007, it spent $2.0 billion on this expense item or less than half, which explains why it made a lot of money in 2007 but lost a lot in 2016.
Free Cash Flow and CapEx
In 2016, Chesapeake Energy had negative free cash flow of $1.0 billion, the company’s smallest deficit in the past decade. Of course, that came as a result of spending just $825 million on the acquisition of new properties.
By contrast, it spent $9.7 billion acquiring new properties in 2007, which resulted in negative free cash flow of $4.8 billion, about six times the amount in 2016. However, in 2007, it managed to generate an operating profit of $2.6 billion.
Lawler was confident that Chesapeake could deliver free cash flow neutrality at current prices given the efficiencies it has been able to deliver from its operations.
“The focus that we have on free cash flow neutrality is at a normalized price deck of $50 (per barrel) and $3 (per mcf), we believe is very achievable for us,” Chesapeake Energy’s CEO said at the Barclays conference. “We are really highlighting value over volumes, and we will be adjusting our capital program accordingly.”
Translation: Chesapeake Energy continues to operate in a leaner, more efficient manner that doesn’t pile on the debt, something it’s been trying to reduce in the last few years through non-core asset sales.
Bottom Line on Chesapeake Energy Corporation Stock
As I’ve said in recent articles about CHK stock, there’s still a lot of risk with investing in the company despite the fact recent quarters have seen improvements in its profit picture.
Free cash flow neutrality certainly helps stem the tide, but it doesn’t solve the bigger problem which is that Chesapeake Energy can’t seem to make money on a consistent basis at current energy prices.
If you’re betting on CHK and can afford to lose the money, I don’t see a problem at less than $4. However, if this isn’t money you can lose, this isn’t a stock for you.
Not now, probably not ever.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.