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Don’t Fall for Chesapeake Energy Stock Right Now

Contrarians may be tempted to get on Chesapeake Energy stock, but the underlying firm is overexposed to market risk

CHK stock - Don’t Fall for Chesapeake Energy Stock Right Now

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Virtually all energy companies suffered severely during the 2014 and 2015 sector crisis. However, few have endured as much pain as Chesapeake Energy (NYSE:CHK). In the trailing five-year period, the CHK stock price has dropped an alarming 86%. Efforts to revitalize the organization have had mixed success.

For instance, in 2016, Chesapeake Energy stock moved up a whopping 58%, providing hope that a recovery was imminent. Optimism was quickly dashed the following year when the energy firm gave up nearly half its market value. This year, shares regained momentum dramatically during the spring, only to have the broader market meltdown get in its way.

Since Oct. 30, CHK stock has gained nearly 16%. But has the volatility finally subsided, or should investors expect more head-fakes? Let’s take a look at what’s driving shares and determine the risk-reward structure.

Chesapeake Energy Stock Is a Gamble on Management’s Turnaround Efforts

Recently, CHK’s management team announced a big risk. In a move that surprised shareholders, the company is buying Wildhorse Resource Development (NYSE:WRD). The nearly $4 billion deal involves a combination of cash and stock, but mostly the latter. In fact, once everything is in stone, WRD shareholders will own 45% of total Chesapeake Energy stock.

Naturally, the markets didn’t respond too kindly to the announcement. CHK stock suffered a double-digit hit on the news. It has barely gained back those losses, and the bearishness isn’t unjustified.

Chesapeake Energy stock is already a deeply leveraged investment. The company’s balance sheet is very poor, even compared to distressed energy players. Notably, it has $9.4 billion in debt and very little cash to speak of ($4 million). If this Wildhorse deal doesn’t work out, things could get ugly in a hurry.

Another factor influencing the bears is management’s prior deleveraging efforts. Essentially, the leadership took a chainsaw to their financials, cutting everything that they didn’t need. During this time, debt steadily declined. Now, they’re going back the other way.

While the move obviously has its critics, Chesapeake had to do something to stay competitive. Should everything go right, the parent company has access to Wildhorse’s Eagle Ford oil projects. With this asset, Chesapeake will more than double its oil production in two years’ time. That should skyrocket CHK stock.

Plus, as I mentioned earlier, the company is buying WRD mostly with its equity. That helps the delicate balance sheet, and its cash flow, which has been anything but confidence-inspiring.

Broader Fundamentals Must Move Favorably for CHK Stock

In order for this Wildhorse gamble to work, the oil markets must move favorably. Considering our current geopolitical dynamics, that’s not something upon which CHK stock can readily depend.

For starters, crude-oil benchmarks Brent Crude and West Texas Intermediate have fallen in lockstep with the major indices. The biggest headwind is the China trade war. Wavering sentiment as to whether the U.S. and China can set aside their differences has stalled the markets.

Even if we make headway in that department, we have another geopolitical crisis with which to contend: the murder of Saudi journalist Jamal Khashoggi. The latest reports allege that Saudi officials have cleaned up evidence instead of investigating the crime. This is a deeply embarrassing situation for President Donald Trump, who has worked hard to promote deals with the Kingdom.

Now on paper, this horrible crime should “benefit” CHK in that the U.S. could impose penalties on Saudi Arabia. But on the flipside, the Saudis would likely retaliate, perhaps by driving down oil prices.

If the energy market does fall again, it would disproportionately impact the CHK stock price. We’re not talking about an Exxon Mobil (NYSE:XOM) or Chevron (NYSE:CVX). Chesapeake can ill afford another sector meltdown, especially not while making a $4 billion deal.

The Markets Are Giving Clear Signals for CHK Stock

I don’t think I’m speaking out of turn when I say most investors are tempted to go contrarian due to the October drop in the CHK stock price. As I go against the grain myself, I can’t blame them.

That said, the markets are making very clear signs about this company. To me, it’s quite telling that Chesapeake Energy stock has been stuck in a bearish trend channel since July. And while the recent days’ comeback is impressive, the overall picture remains ugly.

Finally, the other detractor is that so many better options exist. For all the risk that you’re taking, it’s a pure capital-gains play. Obviously, CHK stock doesn’t pay out dividends. But when it’s technically performing so poorly, you’re getting the worst of both worlds. I just don’t have the confidence to see this through.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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