Chesapeake Energy (NYSE:CHK) had me fooled this morning. It was the first time I’d taken a look at its share price in a while. CHK stock was trading at a whopping $31.40.
I had forgotten the oil & gas producer had completed a 200-for-1 reverse split on April 15, getting back in the good graces of the New York Stock Exchange.
The last time I wrote about CHK stock was in early April before the reverse stock split. At the time, I argued that the proposed production cut by Saudi Arabia and all of the world’s major oil producers, provided the company with a lifeline because oil prices would rise as supply moved closer to demand.
On April 3, West Texas Intermediate (NYSE:WTI) jumped to almost $27 a barrel. As I write this, the price for a barrel of WTI is down 54% to $12.53.
Production Cuts Could Save CHK Stock
Conventional supply-and-demand economic theory doesn’t hold water in the middle of a pandemic. While $32 a share looks a lot prettier than 15 cents, no matter how you look at Chesapeake, it’s not something most investors should touch.
Last November, I suggested that even speculators might want to avoid the company’s stock. At the time, it had fallen from a post-split price of $312 on Nov. 4 to $181 on Nov. 7.
Like the line from the movie Wall Street, I called Chesapeake a “dog with fleas.” Five months later, it remains in the doghouse. Here’s why.
Bankruptcy on the Horizon
Chesapeake’s current Altman Z-Score, according to Gurufocus.com, is -0.77. Anything below 1.81 suggests it could file for bankruptcy in the next 24 months. By comparison, Exxon Mobil’s (NYSE:XOM) is 3.15. Anything above 2.99 is considered to be in the safe zone, likely to avoid bankruptcy.
I’m not sure why you’d want to own an oil & gas stock at the moment, but if you’re going to buy one, Exxon Mobil would be a much smarter call.
Speaking of bankruptcy, InvestorPlace contributor Ian Bezek recently suggested that Chesapeake’s bankruptcy is inevitable. He wrote on April 27:
When corporate bonds are trading at a measly 5 cents, the credit market is saying that the whole company is close to worthless in its present form. You’d have equally good odds buying a lottery ticket that is already scratched off as you have buying Chesapeake stock in this case. Not only is the common stock hosed, the people that lent Chesapeake money likely aren’t getting most of it back either.
Bezek goes on to say that the company “will almost certainly have to be reorganized,” leaving shareholders with nothing but valueless stock certificates.
Over the last three years, Chesapeake’s financial situation has gone from bad to worse. I’m surprised it’s held on as long as it has.
The Bottom Line
Just to give you some perspective on Chesapeake’s chances of riding out this situation, Diamond Offshore Drilling (NYSE:DO) announced April 27 that it filed for Chapter 11 bankruptcy in the U.S. Bankruptcy Court for the Southern District of Texas.
“After a careful and diligent review of our financial alternatives, the Board of Directors and management, along with our advisors, concluded that the best path forward for Diamond and its stakeholders is to seek chapter 11 protection. Through this process, we intend to restructure our balance sheet to achieve a more sustainable debt level to reposition the business for long-term success,” stated Diamond Offshore Drilling CEO Marc Edwards.
Care to guess Diamond’s Altman Z-Score? 0.41, according to Gurufocus.com. 118 basis points better than Chesapeake’s.
At the end of December, Diamond had net debt of $1.82 billion and revenue of $980.6 million. Chesapeake had net debt of $9.45 billion at the end of December, with $8.6 billion in revenue.
By two metrics, Diamond was in worse shape than Chesapeake at the end of 2019.
First, it had more leverage with 1.9 dollars of net debt for every dollar of revenue, compared to 1.1 dollars of net debt for every dollar of revenue for Chesapeake. Second, Chesapeake had $1.6 billion in net cash flow at the end of 2019 compared to just $9.1 million for Diamond.
I’m not suggesting that you should run out and buy CHK stock, but it certainly explains why Diamond declared bankruptcy today.
I’m sure there are optimists out there. I’m not one of them. Chesapeake Energy remains a dog with fleas and most definitely a sell.
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.