Chesapeake Energy (NYSE:CHK) stock’s slump is only getting worse. Shares are off to a miserable start, with CHK stock falling 38% year-to-date. Over the past 12 months, Chesapeake has lost 80% of its value. With the stock falling to just 50 cents per share now, it’s at its lowest levels in more than 20 years. The market capitalization also slid to the $1 billion mark; that’s a humbling level for what was one of the largest and fastest-growing energy companies in the United States.
And, remarkably, things can get even worse. In fact, there’s a good chance that Chesapeake’s stock, at least in its current form, isn’t going to make it through the energy bear market.
Where’s My Cash Flow?
Chesapeake has managed an impressive, if dubious, feat. Over the past decade, it has failed to generate positive free cash flow even one year out of the bunch. Low oil and gas prices, high oil and gas prices? It didn’t matter. The company consistently spent more on capital expenditures (maintaining its existing infrastructure and building new wells) than it ever brought in from its ongoing oil and gas production.
Some investors look at Chesapeake’s earnings and think the company has a decent business. On occasion, Chesapeake has reported strong earnings per share. However, those earnings have never translated into cash flow. The thinking was always that Chesapeake need to invest heavily now, and the rewards would roll in over future years.
This simply hasn’t played out, however. Even in recent years, when Chesapeake has sharply cut investment, it still can’t generate cash. Over the past 12 months, for example, Chesapeake spent $2.4 billion on capital expenditures, but only brought in $1.8 billion in cash flow, making for a deficit of more than half a billion dollars. And now oil and natural gas prices have gone down even more, leaving a wider gap going forward.
Energy Prices Remain the Main Problem
Just a month ago, I warned readers not to buy Chesapeake Energy stock on Iran War fears. How time flies. The Iran situation is now firmly behind us, and meanwhile Chesapeake stock has lost a third of its remaining value over the past month.
It goes to show how little the short-term swings in oil prices or sentiment matter to a company like Chesapeake. The firm is massively indebted to the point that minor moves in oil and gas prices simply don’t move the needle. Even if oil and natural gas went up 50% tomorrow, based on last year’s figures, the company would only generate modest free cash flow. Hardly enough to service its debt, let alone provide dramatic value for common shareholders.
Whether oil is $50 or $60, or natural gas is at $1.75 or $2.25 hardly matters. Chesapeake Energy was built for a far more bullish energy environment, and its balance sheet simply isn’t designed to deal with energy prices anywhere near current levels.
Well Explosion Is Another Negative
Late last month, a Chesapeake well in Texas had a fatal blowout accident. Reportedly, an unexpected quantity of natural gas entered the well that led to an explosion that killed three employees.
As of this writing, the family of at least one of the victims is suing Chesapeake for negligence. While these sorts of accidents are unfortunately all too common in the oil industry, it couldn’t come at a worse time for Chesapeake. The company is struggling to remain viable and solvent. Any questions about the company’s safety standards could bring regulatory oversight and higher costs at a time when the company is already stretched to the maximum.
CHK Stock Verdict
While the stock is still worth $1 billion for now, that’s barely a rounding error compared to its debts. As of last quarter, Chesapeake had $11.8 billion in total liabilities including $9.1 billion in long-term debt.
As a reminder, debtholders have the first claim on Chesapeake’s assets, and equity owners are only entitled to the leftovers if the company can make good on its debts. Increasingly, it’s looking like there isn’t enough there to even satisfy the debtholders, let alone make the equity worth much of anything.
In these sorts of cases, Chapter 11 bankruptcy is often the solution. The company can reduce its debt load by renegotiating its situation in a court-run process. The stock is wiped out, and creditors often convert part of their debt into new stock ownership of the company. Given that Chesapeake has more than 10 times as many liabilities as it has market cap, creditors are already effectively the primary stakeholders in the company.
Chesapeake, thus, is little more than a 50 cent lottery ticket on something extremely unusual happening in energy markets before the company is forced to reorganize. If you want to play a potential rebound in the energy market, you’d be better served picking a company that has a more robust balance sheet. Major companies like Exxon Mobil (NYSE:XOM), Royal Dutch Shell (NYSE:RDS.B) and Continental Resources (NYSE:CLR) are trading at multi-year lows right now. They also have far more staying power to ride out this period of low oil and gas prices.
At the time of this writing, Ian Bezek owned XOM stock. You can reach him on Twitter at @irbezek.
