To some investors, Chesapeake Energy (NYSE:CHK) might appear an attractive “buy the dip” candidate. After all, CHK stock is much cheaper than it was.
Indeed, Chesapeake stock closed Wednesday at just 25 cents. It’s dropped 70% so far this year, and almost 90% just from September highs.
But just because the CHK stock price is cheaper, doesn’t mean that Chesapeake itself is all that much cheaper. Equity investors can’t ignore the company’s debt, which totaled nearly $9 billion at the end of 2019.
That debt needs to be repaid before shareholders receive a penny. And considering that debt, Chesapeake’s valuation hasn’t moved all that much.
At the end of 2019, with its share price at 83 cents, Chesapeake had an enterprise value (market capitalization plus net debt) just over $10 billion. The figure now is around $9 billion — lower, but not markedly so.
That math oversimplifies the story here, but the core point holds. This is not a “cheap” stock. It’s not a “buy the dip” play. CHK has a very real chance of heading to zero — which means even a share price of 25 cents is not an opportunity.
The Oil and Gas Problem
As I wrote last month, Chesapeake simply is on the wrong end of a megatrend. Starting at the turn of the century, Chesapeake borrowed literally billions of dollars to buy oil and gas reserves. For a time, that bet paid off.
Indeed, over the 2000s, CHK stock rose nearly 1,000%. Oil prices on occasion cleared $100 a barrel. Chesapeake’s acreage then leaned more toward natural gas, but a shift away from coal-fired power plants suggested higher demand for that commodity.
Over the last ten years, however, the world has changed. The likes of Tesla (NASDAQ:TSLA) and Nio (NYSE:NIO) have kickstarted an electric vehicle revolution. Now legacy ICE (internal combustion engine) manufacturers are playing catch-up. Oil demand isn’t going to zero, to be sure, but it’s likely to decline over time.
Meanwhile, the U.S. shale boom has unlocked massive amounts of both oil and natural gas. Oil prices averaged less than $60 per barrel (using the West Texas Intermediate benchmark) in 2019. Shale gas is so plentiful as a byproduct of drilling that some producers “flare” it instead of bringing it to market at prices that have hit multi-year lows.
Coronavirus fears have pressured oil prices further. But commodity weakness isn’t a short-term problem. Nor is it a temporary issue. Again, the world has changed.
Digging Out of a Hole
Meanwhile, the fourth-quarter earnings release from Chesapeake last month shows that the company simply can’t survive in this environment.
The headline numbers don’t necessarily show the core problem. Chesapeake did post a loss in the quarter, but on a adjusted basis the loss actually was smaller than Wall Street expected.
The problem is the strategy for 2020. Chesapeake said in the release that it would cut its capital expenditure budget by about 30%. It’s once again cutting operating costs as well, with general and administrative expenses to be reduced over 10%. And it wants to sell $300 million to $500 million in “non-core” assets.
With those moves, the company only is “targeting” some kind of positive free cash flow. It’s not planning on making any material debt reduction. Even $500 million in asset sales would only reduce debt by less than 7%.
But what happens in 2021 and beyond? Lower capital spending means lower production going forward. So do asset sales. Costs can’t be cut forever.
The strategy Chesapeake detailed is that of a desperate company with no way out. It can’t invest in driving long-term production growth because its balance sheet is too loaded with debt. It can, maybe, service that debt in 2020 by cutting capital and operating expenses — but those cuts only kick the can down the road.
Simply put, this is a company backed into a corner, with basically no way out.
Better Alternatives Than CHK Stock
The only thing that could — maybe — save Chesapeake from a restructuring is a steep, and sustained, spike in energy prices. That seems unlikely. There is a structural imbalance between supply and demand in both crude and natural gas.
But even if energy prices rally, there is no shortage of safer, more attractive options out there. Exxon Mobil (NYSE:XOM) just hit its lowest level in more than a decade. Its dividend yields 6.8%. Chevron (NYSE:CVX) has a market capitalization of $181 billion — and this week detailed a plan to return $75 billion to $80 billion to shareholders in the next five years.
More aggressive investors can look to producers like Apache (NYSE:APA) in crude or Cabot Oil & Gas (NYSE:COG) in natural gas. Both stocks would rally nicely if energy prices rise — while both companies have much stronger balance sheets.
Investors aren’t dumping CHK stock because they’re not paying attention. They’re dumping the stock because they’re trying to salvage some value. Chesapeake is in big trouble. Investors who believe the stock is “too cheap” because it’s down 70% need to remember that it can get much cheaper. In fact, there’s likely another 100% to go.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.
