There is no doubt that lower oil prices have affected energy industry stocks. However, Chesapeake Energy (NYSE:CHK) is clearly one of the underperformers. From a 52-week high of $3.57, the stock is currently down 81% at a paltry 69 cents. After the big decline, CHK stock might trade sideways. But I don’t see any positive triggers in the foreseeable future. Therefore, I maintain a “negative” outlook on CHK stock.
Lets’s start with the macroeconomic factors. As tensions deescalate with Iran, oil prices have again trended lower, which is bad news for Chesapeake Energy. Easing trade tensions with China, however, are a positive that could trigger higher GDP growth. That said, it’s unlikely that there will be an immediate impact on oil prices.
The Energy Information Administration (EIA) expects Brent crude oil spot prices to average $64.80 in 2020; the Brent spot price averaged $64.40 in 2019. Therefore, oil can trade sideways, unwelcome news for Chesapeake Energy. In addition, EIA expects marginal decline in natural gas prices in 2020 as compared to 2019. The key takeaway is that energy prices are unlikely to be a trigger for CHK stock upside in 2020.
Deleveraging Should Be Top Priority
If there is one factor that could take CHK stock higher in 2020, it’s deleveraging. For the third quarter of 2019, Chesapeake Energy reported $9.3 billion of total debt. It is worth noting that for Q4 2018, the company reported total debt of $7.7 billion. Therefore, even with a stressed balance sheet, Chesapeake Energy has continued to leverage. That’s one of the primary reasons for sustained stock decline.
The company has reported operating cash flow of $1.2 billion for the first nine months of 2019. But higher capital expenditure has resulted in negative free cash flows. Chesapeake Energy has targeted reduction in capital expenditure in 2020. I believe it should be brought in-line with cash flows so debt does not increase further.
That’s still not enough: the company needs to a clear plan on deleveraging. Chesapeake Energy wants to reduce net-debt-to-EBITDAX to 2.0 from a current level of 2.97.
An important point to note is that Chesapeake Energy has focused on increasing oil production, but it might make sense to sell gas assets. Just for example, the company’s Marcellus assets had 100% gas production in 2019. A key challenge would be to garner attractive valuations for asset sale amidst depressed natural gas prices.
Further, debt refinancing in 2019 delayed asset sales. It is expected that the company might sell gas assets in Louisiana to Comstock Resources (NYSE:CRK) in 2020. The deal is likely to be valued at $1 billion and is certainly not enough.
I admit that selling major assets will impact revenue and cash flow. However, I’m of the mind that avoiding bankruptcy should be the company’s top priority. For that, multiple asset sales are needed within the next 12-18 months. With cash in hand of just $14 million, Chesapeake Energy needs the liquidity infusion.
Just Not Enough Positives
Overall, the biggest concern for Chesapeake Energy is debt. One positive is how debt refinancing has helped the company extend major debt maturities beyond 2023. This factor will be comforting if and when the company is reporting robust EBITDAX and growing cash flows.
However, operating cash flows have declined in 2019 as compared to 2018. If debt servicing metrics do improve, the stock will trend higher, but for that, oil and natural gas prices need to move higher, which seems unlikely in 2020.
Chesapeake Energy has also increased share of oil production from 19% in Q4 2018 to 26% in Q4 2019. This is another positive and will help in EBITDAX margin expansion potentially in 2021. Higher capital expenditure allocation toward oil-weighted assets will further help in increasing oil production share.
Yet these positives are overshadowed by debt and bankruptcy concerns. Therefore deleveraging has to be the top priority in 2020.
The Bottom Line on CHK Stock
CHK stock has declined sharply throughout 2019 and I expect the stock to remain sideways to lower in 2020. News of asset sales could trigger stock upside, as could higher energy prices.
For the time being, though, the challenges are likely to sustain. There may be potential trading opportunities on asset sale news, but Chesapeake Energy is far from being a portfolio stock.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
