Reports surfaced Mar. 16 that Chesapeake Energy (NYSE:CHK) had hired debt restructuring advisers. The advisers included restructuring lawyers Kirkland & Ellis LLP and Rothschild & Company investment bankers who are familiar with reworking debt. Their job is to figure out what to do about the oil and gas company’s $9 billion in debt. The announcement did little for CHK stock.
In early March, I wrote about the company’s plan to do a reverse split to stay in the good graces of the New York Stock Exchange. I finished by stating that stock split or not, Chesapeake was a joke of a stock. And while I feel for the employees, CEO Doug Lawler should have been more forthright with investors these past few years as it struggled to find its footing and positive free cash flow.
Now it wants investors to believe that restructuring is the tonic to cure what ails it.
Seriously? If Saudi Arabia wasn’t so hellbent on capturing control of the global oil market, I might be able to understand the argument. However, unless the Saudis have a change of heart, it is game over for Chesapeake Energy. Here’s why.
$9 Billion in Debt with No Chance of Selling Assets
Former Saudi Arabian government advisor Nawaf Obaid’s Mar. 20 opinion piece in CNN Business explained how difficult it would be for an oil producer not named Saudi Aramco to survive in a world where oil prices fall as low as $15 per barrel.
“The Saudi finance ministry and the Saudi Arabian Monetary Authority (SAMA) are designing financial government expenditure plans that can sustain oil prices falling as low as $30 per barrel on average for at least the next five years, with temporary dips as low as $15 per barrel, according to various government financial projections,” Obaid stated.
“Aramco CFO Khalid Al Dabbagh re-emphasised this point by saying ‘We [Aramco] are very comfortable we can meet our shareholders’ expectations at $30 a barrel or even lower.’”
At the very least, Obaid stated, Saudi Arabia won’t stop the price war until it has become the world’s largest producer of oil. Currently, it’s in third place but is ready to pass Russia in the next month or so. It should pass by the U.S. within 24 months, at which point it will have a sustained production capacity of 13 million barrels of oil per day.
Forget about Chesapeake Energy. This situation should scare the heck out of Exxon Mobil (NYSE:XOM).
Saudi Aramco’s prospectus said that its cost to produce oil was less than $9 a barrel. By comparison, U.S. shale oil costs an average of $23.35 a barrel to get out of the ground. Non-shale crude costs $20.99 a barrel, or more than twice what it costs the Saudis.
So, if this price war goes on for more than two years, who exactly is going to buy Chesapeake assets when they know they’re not going to make money on these assets for some time?
I might not be a restructuring expert, but it seems that if Chesapeake can’t sell assets to reduce its debt, the only other possibility, other than declaring bankruptcy, is to improve its current cash flow so that it can convince lenders to push back more of its debt that’s coming due in the next few years.
The problem is that unless Saudi Arabia changes its mind on a $15 to $30 barrel of oil and the coronavirus doesn’t put us into a backbreaking recession, Chesapeake’s cash flow is sure to deteriorate rapidly.
Restructuring Won’t Save CHK Stock
I’m convinced that speculators continue to prop up its share price. As I write this, it’s at 18 cents, about where it’s traded for the past three weeks.
As my colleague, Ian Bezek, recently stated, Chesapeake has tried everything possible to keep the lights on, including cutting expenses to the bone, and it still couldn’t generate positive free cash flow.
Now, with the Saudi’s putting the rest of the world in a vice-like death grip, only the most sound balance sheets will survive. Chesapeake isn’t that.
I would expect that the company’s Altman Z-Score will continue to worsen. Barring a miracle, Chesapeake’s advisers will likely have a meeting with a bankruptcy judge in the not-too-distant future.
CHK stock is definitely not a buy.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.