Inarguably, one of the ugliest names in any industry this year is Chesapeake Energy (NYSE:CHK). Constantly flirting with literal penny stock status, the CHK stock price has largely trended down since mid-April. But in November, Wall Street had enough, tumbling shares down below the key psychological threshold of $1.
What was the straw that broke the camel’s back? On Nov. 5, Chesapeake released its earnings results for the third quarter. To everyone’s disappointment, the company missed estimates for earnings per share. This represented the third consecutive time that CHK missed EPS targets. Not surprisingly, Chesapeake Energy stock began gushing red ink.
But the real catalyst for the hemorrhaging came from management’s admission that it had “substantial doubt” about its ability to move forward as a growing concern. Here’s the context: over the last five years, the CHK stock price has dropped a dubiously remarkable 96%. Through that time, analysts everywhere have heaped on the negatives of the company; namely, the extreme debt levels and the cash burn.
The leadership team itself affirmed the critics’ warnings. Look, corporate executives are paid the big bucks in part to spin a positive narrative wherever possible. That they apparently no longer saw a pathway forward was unacceptable for those holding Chesapeake Energy stock.
But recently, CHK stock received much-needed positive news. On Wednesday, Dec. 4, Chesapeake announced that they made a series of debt financing deals. The intricate details are complex, but the bottom line is that the energy firm has about five years to pay back the loan. Essentially, the executive team has some breathing room to get the organization back in shape.
Should you gamble on Chesapeake Energy stock now? Here are my thoughts:
CHK Stock Is More Interesting
Before we get into it, I should emphasize one point: nothing about the above debt refinancing changes the core characteristic of Chesapeake Energy stock. Over the last few years, CHK has been a gamble and it still is.
However, the odds have shifted in your favor. Be careful, though: I did not say the odds are favorable. Merely, we transitioned from fourth-and-forever to fourth-and-long.
It’s still fourth down. And you still have to read the defense, make the throw, have the receiver catch the ball, and gain enough yardage to move the sticks.
Now that I think about it, this football analogy perfectly describes where we stand with CHK stock. Yes, the debt deal is huge. Anytime you can put more time on the clock, it’s a net positive. While the recovery trek for Chesapeake is extraordinarily difficult, at least gamblers can say it exists.
It goes something like this: first, the debt relief suddenly pushes management in a much better negotiating position related to assets they wish to sell. Prior to the deal, prospective buyers knew that CHK was downright desperate.
Second, management has a much more viable path to transition Chesapeake Energy stock from a natural gas investment toward an integrated hydrocarbon producer. The latter is a cute way of saying crude oil.
Plus, this transition makes economic sense. Like it was in years past, natural gas prices have been mostly disappointing, punctuated with brief upside spikes. In contrast, Brent Crude Oil is starting to pick back up. Notably, oil prices are in the black so far this year, while natural gas prices are deep in red ink.
You might be thinking to yourself that this strategy could work. However, we need to discuss the flipside: so much must go right.
But Chesapeake Has No Room for Error
Going back to my football analogy, if the energy firm does everything right, the CHK stock price could skyrocket. That’s the optimism driving contrarians right now.
However, what makes me hesitant is that everything must go according to plan. Not only must management make the right decision and execute, they have critical elements which they cannot control (the receiver catching the ball and running with it).
If a Democrat wins the White House in 2020, that could be it. Increasingly, liberal politicians have embraced renewable energy and go-green initiatives. Some of the Democratic candidates appear downright hostile to big oil.
Second, oil prices must reasonably sustain their current levels. Chesapeake Energy stock isn’t entirely dependent on a booming oil price, but it can’t crater for prolonged periods.
Finally, the economy must move in the right direction. That’s not a guarantee, particularly since we don’t know for sure where we stand in the U.S.-China trade war. From the latest rumblings, we’re a step closer to a deal. But I’ve heard that one before. And distrust of China is not an exclusively conservative sentiment.
Here’s the bottom line: the debt financing arrangement makes CHK stock genuinely appealing to contrarians because a recovery pathway has opened. But the risks are not just within management’s control. So many other variables must move favorably too. For most investors, that’s just too much.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
