Oil and gas companies have been hit hard by waning demand and ultra-low oil prices over the past few years. The challenging environment in the energy sector couldn’t have come at a worse time for Chesapeake Energy (NYSE:CHK), a fracking company whose finances have been rapidly deteriorating over the past year.
As a result CHK stock has made its way into penny-stock territory — appealing to only the most speculative of investors. While better than expected Q4 guidance coupled with higher oil prices has contrarians starting to circle, the firm’s tattered balance sheet is enough to keep me on the sidelines.
Here’s a look at why Chesapeake isn’t investment-worthy even at these levels.
Pivoting to Oil Hasn’t Helped
A decade ago when fracking was all the rage, Chesapeake shares were flying high as the firm capitalized on new energy sources. However, one disgraced CEO and a strategy shift later, Chesapeake’s share price is trading in the gutter with very few lifelines remaining.
The firm pivoted toward oil over the last few years, but with both natural gas and oil prices trading at a discount right now, the shift has done little to revive Chesapeake’s future. At the end of January, Chesapeake management announced that it could reach free cash flow in 2020. Management also said the firm’s average estimated equivalent production rose to between 476,000 and 478,000 barrels of oil equivalent in Q4. That’s up from the firm’s average daily production of 464,000 barrels of oil equivalent.
Plus, as InvestorPlace’s Larry Ramer pointed out earlier this week, there’s a good chance that Chesapeake was able to lock in higher oil prices when tension in the Middle East drove them upward earlier this year. Ramer says Chesapeake may have had the opportunity to lock in oil prices near $65 per barrel for up to three years. If that’s the case, that would certainly be a boon for CHK stock.
But that is a very big if — and even if the firm does manage to secure higher oil prices, it’s not enough to cover the company’s massive debt obligations.
Debt Makes CHK Stock a No-Go
At the end of 2019, Chesapeake management warned that the company was on the verge of bankruptcy. Since that time, there hasn’t been much concrete evidence that the company has been able to dig itself out of that hole. Speculation that the firm may have locked in higher oil prices simply isn’t enough to convince me that things are drastically improving.
But what should really raise a red flag for investors is Chesapeake’s insurmountable debt obligation. According to CFRA analyst Paige Meyer, Chesapeake’s debt will mature in September of 2023. However that date could be pushed forward if the firm breaches its covenants — something CFRA sees as a possibility. On top of that, Meyer points out that Chesapeake’s long-term debt is worth more than its oil and gas reserves — a worrying sign for the future:
“CHK relies on its credit facility to fund short-term needs. It has $2.2B available on this facility and the borrowing base matures in September 2023. However, we believe CHK risks breaching its leverage covenant, which would be an act of default and accelerate when debt is due. CHK’s long-term debt is approximately 105% of the value of its oil & gas reserves as of the most recent reserve report (Q4 2018), though we note this was pre-Wildhorse merger.”
Can Chesapeake Turn Things Around?
That’s not to say CHK stock is heading to zero, but the firm is certainly on that path right now. After all, debt is often restructured and covenants renegotiated. Still, the energy sector is volatile at the moment as the space continues to face headwinds. Growth is difficult to come by even for some of the biggest players in the industry— let alone for Chesapeake and its struggling finances.
As the firm issued a going concern warning just a few weeks ago, buying Chesapeake stock now would be akin to gambling. There’s a chance the firm will emerge from its financial troubles over the next year, but that possibility looks slim and evidence seems to be pointing to the contrary. Instead, investors interested in picking up an energy stock should look to some of the bigger names in the industry who have the cash and the stability to weather the storm.
As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities.
