Chesapeake Energy (NYSE:CHK) stock has already been bogged down due to debt concerns. CHK stock currently trades at 48 cents, having declined by a massive 82% in the last one year. Even after the deep correction, I believe that there is no respite for investors.
Talking about the balance sheet, Chesapeake Energy reported total debt of $9.3 billion as of September 2019. Based on the EBITDAX — the measure of an oil or gas company’s ability to produce income on its operations in a given year — this translates into a leverage ratio of 3.0. The company also reported a low cash balance of $14 million.
Possibly, balance sheet concerns might already be discounted in the stock price considering an 82% decline. However, I am bearish through fiscal year 2020 due to macroeconomic factors that will affect the company’s credit outlook.
Impact of Coronavirus Outbreak Likely to be Significant
The coronavirus outbreak in China is likely to have deeper-than-expected implications on the global economy.
As the coronavirus spreads beyond China, Oxford Economics believes that it could cost the global economy $1.1 trillion in lost income. Michael Mina, assistant professor of epidemiology at the Harvard T.H. Chan School of Public Health opines that it’s “potentially inevitable that we will start seeing cases locally throughout the world.”
A very predictable scenario is that oil and natural gas prices remain sideways or lower. This will translate into shrinking EBITDA margin and cash flows. Even if Chesapeake continues to reported healthy production growth, credit metrics could potentially worsen.
Talking about natural gas prices, Schneider Electric (Other OTC:SBGSY) commodity analyst Christin Redmond believes that “it will be very difficult for [natural gas] prices to break back above key resistance of $2.00/MMBtus.” The U.S. Energy Information Administration also believes that natural gas prices will average $2.29/MMBtu through 2020.
In addition, Chesapeake Energy has been ramping up oil production. Even Brent oil price is below $60 per barrel. As the real economic impact of coronavirus outbreak becomes clearer, I expect oil to trade in the range of $50 to $55 per barrel.
Therefore, the company’s EBITDAX and cash flow will remain depressed even if production growth sustains. This will continue to put pressure on the balance sheet.
Heading Toward Bankruptcy?
With the stock below a dollar, there is a big question on the company’s survival.
I believe that the stock is likely to remain depressed, but Chesapeake Energy can navigate the current headwind. The following backs my view:
Chesapeake Energy is likely to report an annualized EBITDAX of $2.48 billion. Further, the annualized interest expense is likely to be $650 million. This implies an EBITDAX-interest-coverage-ratio of 3.8. Therefore, even with $9.3 billion in debt, the company still has a smooth debt servicing profile. Of course, the risk is that EBITDAX declines in FY2020. Even with that factor discounted, the interest coverage is likely to remain strong.
For FY2019, Chesapeake Energy is likely to report operating cash flow of $1.5 billion. However, free cash flow will remain negative as capital expenditure has remained high through the year. For FY2020, Chesapeake Energy is scaling down capital expenditure in the range of $1.3 billion to $1.6 billion. The objective is to keep investments within cash flows. Therefore, I don’t expect further leveraging in FY2020.
In its latest press release, Chesapeake Energy mentioned that for FY2020, the company has “protection on a portion of its 2020 projected oil production at an average price of $59.28/bbl and on a portion of its 2020 projected gas production at an average price of $2.76/mcf.” Even as oil and gas prices remain weak, hedged positions are likely to ensure that cash flows don’t decline significantly.
Final Take on CHK Stock
CHK stock has been on a sustained decline and a short-term trading bounce can’t be ruled out. However, macroeconomic factors will dictate the stock trend and I am bearish on that front.
For Chesapeake Energy, FY2020 is more about survival through lower investment and potential deleveraging than focusing on growth. Any further asset sale would help on the deleveraging front.
Overall, investors need to remain in the sidelines while short-term traders can consider a small exposure to CHK stock.
Faisal Humayun is senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.