Last month, the hope of a cold winter ahead lifted shares of Chesapeake Energy (NYSE:CHK). CHK stock recovered from its $0.55 yearly low and seemed set to break above $1.00.
Yet the reality of low natural gas demand shaved 20% from Chesapeake as it ended last week at $0.73. Investors who bet on a natural gas rebound now need to worry about the warmer weather and Chesapeake’s stock price.
What will it take for CHK to rebound back to the $1.00 so that it does not get delisted?
Natural Gas Price Slide
This year started with futures sliding further on January’s warmth. Naturalgasintel said that “warmer-than-normal patterns through the first half of January continued to pressure natural gas futures lower.”
This also hurt shares of Antero Resources (NYSE:AR) and Southwestern Energy (NYSE:SWN). Persistently warm weather will pressure natural gas prices to the downside, hurting Chesapeake Energy investors.
Despite the unpredictable nature of the weather, natural gas prices at the $2.00 level in the winter is unprecedented. Speculators just need winter showing up again, with cooling temperatures driving natural gas demand higher.
Supply Cuts
Natural gas producers need to cut output sharply to bring back the demand-supply equilibrium, but companies like Chesapeake Energy are unlikely to do that.
The company’s estimated revenue will fall by 8% in 2019 and another 8% in 2020. Its net income will fall into the red, too.
Current shareholders might as well hold the stock for the next two months, betting on cold weather lifting natural gas demand.
$1.5 Billion Lifeline
Last month, Chesapeake announced that it secured a $1.5 billion lifeline through a $1.5 billion term loan facility. It will use the proceeds to buy 6.875% senior notes due 2025.
The cash raise and debt repurchase will improve the company’s financial flexibility. By re-financing at a discount, Chesapeake has lower costs for managing its debt. In effect, the company is not in any near-term danger of declaring bankruptcy. The commercial market will continue accumulating natural gas futures in anticipation of improving commodity prices.
Banks are working with Chesapeake in keeping the company’s operation afloat as it navigates through a down market. This is similar to the 2016 downtrend, in which CHK shareholders survived.
Fair Value
A total of 9 analysts offering a 1-year price target on Chesapeake Energy have a $0.79 price target (per Tipranks).
Aggressive investors who prefer to do their own number-crunching may use a Revenue Multiples model. Assuming an LTM revenue multiple of 1.7 times, CHK stock is worth well over $1.00. You can see the Revenue Multiples model here.
Upside Potential
Chesapeake posted record oil production at its Brazos valley holding (slide 5) with its well costs falling 21% over 2018 levels. As it expands exploration activities and lowers operating costs, the company may reward investors. It just needs better natural gas prices throughout the course of 2020.
Management is making the best of the situation by allocating most of its capital to its highest-margin oil assets. Continued reduction in production and G&A (general and administrative) costs will help conserve cash levels.
On its conference call, management demonstrated its ability to constrain its spending:
We expect to continue to make strides using all the same levers that we have; cost discipline in all aspects of our business; asset sales; hedging prices as they rise; capital markets transactions; and of course, working very closely with our bank group which we do on a regular basis.
Source: SA Transcript
Management is doing what it does best: controlling costs because it is possible and keeping a strong relationship with its financial supporters.
The Bottom Line on CHK Stock
At $0.73 a share, CHK stock is like a call option on the natural gas market. Investors seeking exposure in the volatile market could hold a small position. But if winter does not come, the stock will continue its descent.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.
