Just when it looked like things couldn’t get any worse for U.S. shale oil producers like Chesapeake Energy (NYSE:CHK), they did.
Already reeling from falling demand in the wake of the novel coronavirus outbreak going global, oil prices and stocks had their worst day since 1991 on news that Russia and OPEC have begun an all-out price war. CHK stock didn’t buck the broader oil sell-off.
A month ago, this stock was up near 50 cents. Today, it trades below 20 cents.
At this point in time, Chesapeake appears to be out of options and out of time, as sustained low oil prices won’t allow the company to produce enough revenue or cash flow to service its debt and operations. Bankruptcy is now a real possibility.
So if you’re a trader, maybe you buy this dip and hope for a quick turnaround on hopes that the oil price war fades. But, I’m an investor — not a trader — and as an investor, I’m staying away from CHK stock. Long-term, this stock looks doomed.
Rough Times Ahead
The oil market and by extension, U.S. shale oil producers like Chesapeake, are due for rough times ahead.
In a nutshell, Russia and Saudi Arabia starting a price war inflicts some damage to each of those countries. But it inflicts far more damage on U.S. shale oil producers. That’s because Russia and Saudi Arabia have deep pockets and plenty of resources. Both can absorb the blow of low oil prices for a few months.
U.S. shale oil producers cannot. They are cash-strapped, they are debt-burdened and no one wants to step in and save them, because banks and equity shareholders have grown weary of the industry’s inability to generate profitable returns.
So if oil prices remain low for the next few months, that will put tremendous pressure on U.S. shale oil producers. Many of them, like Chesapeake, may actually succumb to bankruptcy.
“Probably 50% of the public [exploration-and-production companies] will go bankrupt over the next two years,” said Pioneer Natural Resources CEO Scott Sheffield, per the Wall Street Journal.
Sure, the coronavirus headwind is temporary. If you look at data from China (just 26 new cases on March 10) and South Korea (just 35 new cases), then it appears that globally this outbreak should die down come April or May. At the same time, Russia and Saudi Arabia won’t fight forever.
“Saudis and other Middle Eastern producers have their budgetary constraints [and] Russia is starved for cash,” said Jonathan Barratt, chief investment officer of Probis Group. “So the dynamics of all those put together will mean they will come to an agreement somewhere.”
In other words, supply and demand trends in the oil market will improve. But not yet. Instead, for the next few weeks to months, the oil market will remain under pressure.
Chesapeake Looks Doomed
The big problem with Chesapeake is that it remains unclear if this company can survive if oil prices remain depressed for the next few months.
Just look at the numbers. There’s only $6 million in cash on the balance sheet. By comparison, there’s $9.4 billion in debt. Interest payments alone amount to about $650 million a year. Yet, operating profits and net profits are negative. Operating cash flows are positive, yes. But, this isn’t a capex-light business and free cash flow last year was negative $557 million.
Those numbers won’t get better if oil prices remain low.
Revenues won’t rise. Profit margins won’t rise. The company will continue to report operating losses. Net losses will be wider because interest payments will remain large. The company will continue to burn cash.
But the company doesn’t have much cash left to burn and credit looks maxed out.
So, where does Chesapeake go now? No one really knows, but the outlook is quite bleak.
Bottom Line on CHK Stock
If there’s a favorable development in the oil market — the price war eases or demand bounces on easing coronavirus fears — then CHK stock will catch a rebound bid.
But that won’t change the long term fundamentals here, which are that Chesapeake is an unprofitable, over-levered U.S. shale oil producer that has been flirting with bankruptcy for several years.
That’s a dangerous combination. As such, as a long-term investor, I’m steering clear of CHK stock.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
