Things keep going from bad to worse for Chesapeake Energy (NYSE:CHK) stock. The shares have imploded over the past year. Last summer, on a split-adjusted basis, they still traded for as much as $400 per share. Now they’re going for $40 each. Chesapeake has plunged 76% year-to-date, even after this week’s substantial bounce.
After a total collapse like this, traders might be tempted to buy Chesapeake. The oil market crashed, and that has folks out wanting to “buy the blood in the streets” as well. Surely after dropping this far, Chesapeake must finally bounce, right? In the short run, it might enjoy a further rebound thanks to technical factors. But in the big picture, there’s a good chance this stock is going to zero. Here’s why.
A Stunning Reverse Split
Earlier this month, Chesapeake executed a reverse split of its stock. That’s not an unusual move for a company whose shares have fallen into penny stock territory. What was weird, however, was the size of the split. Chesapeake performed a shocking 1-for-200 reverse split. If you previously owned 1,000 shares of CHK stock, for example, you ended up with just five measly shares after the split.
Creighton University finance professor Robert Johnson put it bluntly: “A 1-for-200 reverse split simply confirms what the market already knows — the firm is on life support.” Coming into 2020, Chesapeake had around $10 billion in debts. That’s simply a preposterous sum for a company which now has a market capitalization of just a few hundred million dollars and which consistently loses money every quarter. There’s no realistic path to managing that debt unless energy prices enjoy a miraculous recovery.
Natural Gas Won’t Save the Day
Some bulls may argue that while oil is indeed a massive problem, Chesapeake can still make good on its debts due to natural gas. Before its recent pivot, CHK was primarily a natural gas player, and it still has extensive operations there.
The theory goes that with oil production set to plummet, this will boost natural gas. That’s because oil produced via fracking, such as what you get from Texas’ Permian Basin, comes with a ton of gas as well. This is called associated gas, as it tags along with oil in the extraction process.
In recent years, a lot of associated gas has come to market as fracking companies stepped up their production. Going forward, associated gas production will decline along with shale oil, causing natural gas prices to rise.
There are two issues with this, however, as it relates to Chesapeake. One, they have major bond payments due this summer. They don’t have time to wait around for natural gas prices to improve in a couple of years; they need a massive price recovery immediately. And two, natural gas demand is set to fall sharply with the novel coronavirus. Much industrial activity has come to a halt, reducing usage.
Liquefied natural gas “LNG” exports are set to plummet as well. Falling oil prices may boost stronger natural gas companies’ fortunes to a degree, but it’s way too late to matter for Chesapeake.
The Bonds Confirm Chesapeake’s Fate
Chesapeake’s massive debt is largely publicly traded; you can buy a piece of the company’s obligations on the bond market. If everything goes well, you enjoy a decent interest rate for a few years, and then the company pays back your principal in full. But things aren’t going well. They’re going so badly, in fact, that Chesapeake’s various debts are trading in the neighborhood of just 5 to 15 cents on the dollar.
Take this particular bond, for example. It pays a 5.37% annual interest rate and matures in June 2021. A buyer would thus earn more than 5% per year through next June, and then get back face value, which is 100 ($1) for bonds. Those bonds, however, currently trade at just 4.5 cents. That’s a more than 95% discount. Thus, you could, theoretically, buy $10,000 of bonds for just $450 today and have Chesapeake pay you $10,000 next June if the company is still solvent then.
Given the ludicrously low price there, it should be clear that the company is highly likely to go bust in the near future. The bond market isn’t stupid, after all, it’s not just giving away free money here.
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.
Simply put, when the bond market is offering something absurd, like prospective 20-to-1 returns, merely for a company staying operational for a year, you should assume the end is near. I don’t recommend buying the bonds either, but at least bondholders have a claim in bankruptcy court. The common stock, by contrast, is likely to get nothing in Chapter 11.
The Bottom Line on CHK Stock
Sure, in the short run anything is possible. As a pure trade, Chesapeake could go up for a few more days. With the reverse split, however, even that outcome is less likely; it’s much easier to short squeeze a penny stock than one trading up at CHK stock’s current double-digit share price. And in any case, the long-term outcome is crystal clear.
The company will almost certainly have to be reorganized, with the common stock being wiped out. There’s simply way too much debt to survive with even relatively low oil and gas prices, let alone the crash we’ve seen this week.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.
