Chesapeake Energy (NYSE:CHK) stock has been on the road to nowhere for the past five years, taking the share price from a peak of more than $21 to below $1.00 today. The sad truth is that Chesapeake now has little chance of surviving without selling off a large portion of its oil and gas assets.
CHK stock at 86 cents is the moral of a cautionary tale about the use of debt in a cyclical industry. Based on last quarter’s financials, the company now has over $9.1 billion in crushing debt. But shareholders equity was only $4.7 billion.
Moreover, since then, the situation has deteriorated.
Chesapeake Energy’s Soul-Crushing Debt
The antagonist in this cautionary tale features is negative free cash flow. Chesapeake’s cash burn topped $241 million last quarter. It was still drilling oil and gas wells hoping that low gas prices would revive. That hasn’t happened.
Moreover, gas prices, which account for over 60% of Chesapeake Energy’s revenue, stayed low in Q4. So Chesapeake started discussions with a willing buyer for a portion of its assets, according to news reports.
But management got cold feet leaving Chesapeake spending late December cutting a deal with some of its most pressing debt holders. They restructured $1 billion in borrowings and exchanged it at 60% on the dollar for new notes. As a result, Chesapeake stalled the proposed $1 billion in asset sales.
But here’s the problem. The interest rate is now much higher on this lower debt principal. So the net cash drain in interest costs is about the same.
Moody’s sees it this way. Here is what senior analyst John Thieroff wrote on Dec. 4, in anticipation of the deal close:
“If successful, the tenders should allow Chesapeake to reduce its debt burden, simplify its corporate structure and provide better asset coverage to its creditors. “However, the high interest rate on the proposed borrowings — the second lien notes in particular — will limit the amount of interest expense reduction Chesapeake will achieve through the exchange.”
The deal closed on Dec. 20. Chesapeake Energy filed SEC documents and on Dec. 26 and Dec. 27.
Yes, the deal allowed Chesapeake to stave off bankruptcy. But it did nothing to change Chesapeake’s soul-crushing debt and interest costs.
Chesapeake Energy Stock Needs More Asset Sales
Chesapeake Energy needs low energy prices to produce positive free cash flow. According to a Bloomberg Intelligence energy analyst, Chesapeake needs oil prices above $60 and natural gas above $2.75.
But here’s the problem. Natural gas has been crashing. Last week it fell to $2.15. Chesapeake is still burning cash.
Investors in Chesapeake Energy stock can expect another bad quarter ending Dec. 31. The issue now is whether Chesapeake can stay solvent.
Without the $1 billion in asset sales that it previously was considering, the company is likely running out of liquidity.
Moreover, Chevron (NYSE:CVX) just announced a large asset writedown of its oil and gas assets. this will portend bad news for Chesapeake, according to at least one Seeking Alpha blogger.
What Should Investors in Chesapeake Energy Stock Do?
CHK stock needs 15 cents … for a month. What’s that? It’s the chump change that will push the share price above $1.00. And, it needs to come up with a plan to keep Chesapeake stock trading for more than a buck for more than 30 days.
The only way for that to happen, without an asset sale, higher energy prices or a takeover, is for Chesapeake to do a reverse split. That means that for every share held, the company exchanges them for fewer shares.
For example, this could be an exchange such as 1 new share for every 10 old shares, etc. The effect is to raise the CHK stock price by 10 times since there would be 10 times fewer shares outstanding.
The problem with this financial engineering is that it is a sign of a company in trouble. Serious institutional investors know this. The reverse split brings out more short sellers betting on the fall of CHK stock. That pushes it down further.
So buyer beware in Chesapeake Energy stock. The company pays no dividend, has poor economics and is close to insolvency. Unless management decides to sell assets or economic conditions push up natural gas prices, Chesapeake Energy stock will drop further.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers a two-week free trial.
