Already-battered Chesapeake (NYSE:CHK) stock was hit by a perfect storm last week. Both energy prices and the stock market collapsed amid fears that the coronavirus from China will rapidly spread around the U.S., Europe and the rest of the world.
Meanwhile, company CEO Doug Lawler likely attracted more short sellers to bet against the company’s stock by revealing that Chesapeake planned to soon carry out a reverse split of its stock. Since it’s easier for short sellers to rack up huge profits on stocks trading at 40 cents than for those trading at $4, Lawler’s comment probably made many speculators even more eager to short the shares than they otherwise would have been. And last but not least, many on Wall Street are currently convinced that the oil and gas industry is headed for disaster.
Priced for Bust Without Much Chance of it Happening
On a few important points regarding Chesapeake, I agree with Vince Martin — another InvestorPlace contributor. He believes that, barring a miracle, Chesapeake is headed for bankruptcy. First, we agree that the shares are priced as though the company is definitely headed for bust, Secondly, we agree that, if oil and gas prices stay where they are, the company is definitely headed for bankruptcy. Finally, like Martin, I think that CHK stock can jump tremendously from its current depressed levels. (He thinks that any rally will only be very short-lived, while I think that the shares can surge for years).
But unlike Martin, I don’t think the shares are almost definitely headed for $0. One key reason for my view is that I don’t believe oil and gas prices will stay nearly as low as they are now.
First, oil and gas prices are very low now largely because comments last week by a Centers for Disease Control official and actions by the state of California have convinced many that a coronavirus epidemic will definitely hit the U.S. and strangle its economy. Specifically, the CDC official stated “we expect we will see community spread in this country,” adding “It’s more of a question of exactly when this will happen.” Many took her comments to mean that the virus would soon be spreading to many thousands of people all over the country.
The head of the CDC later walked back her comments, but they had already spooked investors beyond repair. Secondly, after one coronavirus case of unknown origin was found in California, the state decided to test 8,400 people for the illness, leading to the impression that the illness has spread all over the state. But in fact as of March 1, California had only identified three cases of the virus that had been contracted in the state.
Further. there’s some evidence that the virus doesn’t spread very quickly in warm weather. According to comments attributed to Professor John Nicholls of the University of Hong Kong’s Department of Pathology, “sunlight will cut the virus ability to grow in half, so the half-life will be two-and-a-half minutes and in the dark it’s about 13-20 minutes. Sunlight is really good at killing viruses,” he said. The professor reportedly added, “…and high humidity, the virus doesn’t like it either.”
That could be why the virus hasn’t spread much in Singapore, Hawaii, Australia, and southern Italy, all areas that had some exposure to coronavirus but which all have warm weather now. If Nicholls is correct, then the virus may not spread very quickly once the weather turns warm in most of the world in a few weeks. (Also worth noting is that the weather is already pretty warm in northern California.) Finally, it’s also important to point out that, even with its coronavirus epidemic and its less-than-great healthcare system, China’s economy hasn’t collapsed and isn’t even expected to enter a recession.
So, all in all, there’s a great chance that oil and natural gas prices will rally tremendously once the market realizes that a huge U.S. epidemic isn’t inevitable and that, even if one arrives, it won’t destroy the economy. Further, even if an epidemic does hit the U.S., it could likely slow to a snail’s pace in most of the country within several weeks, so energy prices are likely to rebound then,
FCF Guidance Seems Solid
Assuming oil and gas prices rebound to their pre-coronavirus-panic levels of around $53 per barrel and nearly $2, respectively, the company has a good chance of avoiding bankruptcy. At those levels, its banks will be convinced that it will likely meet its guidance of positive free cash flow in 2020. After all, its EBITDA, excluding exploration costs and one-time items, came in at $665 million in Q4 and $2.5 billion in 2019. EBITDA is a measure of cash flow, and, as the company pointed out on its Q4 earnings conference call, Chesapeake can cut its exploration expenses.
Further, as I’ve noted previously, banks don’t usually like to push companies with positive free cash flow into bankruptcy. Finally, at those oil and natural gas prices, Chesapeake would likely be able to find buyers for the land it’s looking to sell at decent prices, enabling it to easily make its near-term debt payments and giving banks an additional reason not to force it into bankruptcy.
It’s also worth noting that, as Martin pointed out, much of Chesapeake’s energy production is hedged through the end of 2020. Consequently, the company’s financial results are unlikely to be disastrous this year. And by 2021, I’m confident that coronavirus will no longer be seen as a huge threat to the nation or the economy. Also by that time, exports to China will likely meaningfully boost oil and natural gas prices above their January 2020 levels.
Bottom Line on CHK Stock
Obviously, Chesapeake’s shares aren’t for faint of heart, risk-averse investors, and I wouldn’t advise anyone to make the shares more than 5% of their portfolio. But for anyone who’s not too risk-averse and believes that coronavirus is not very likely to wreck the economy, while Chinese purchases of U.S. oil and gas can boost energy prices, Chesapeake is worth a small gamble.
As of this writing, Larry Ramer owned shares of Chesapeake stock. Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been GE, solar stocks, and Snap. You can reach him on StockTwits at @larryramer.