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The Rally in Chesapeake Energy Stock Just a ‘Dead Cat Bounce’

Traders are having some fun with CHK, but investors should run far, far away

Chesapeake Energy (NYSE:CHK) stock nearly tripled in four sessions last week and on huge volume. That might tempt investors into believing that something has markedly changed relative to the company’s prospects.

chk stock
Source: Casimiro PT / Shutterstock.com

That’s simply not the case. I’ve been trying to steer investors away from CHK stock for some time now, and the news has only gotten worse.

Chesapeake’s debt was a significant problem at the start of this year. The spread of the novel coronavirus along with a price war instigated by Saudi Arabia both have led crude prices to plunge. Those lower prices only add to the balance sheet concern.

Even before those developments, Chesapeake was hanging by a thread. With West Texas Intermediate crude at $15 per barrel, bankruptcy seems all but certain. Right now, traders are having some fun with CHK stock — but investors should stay far, far away.

Why CHK Stock Soared Last Week

It’s not clear why Chesapeake Energy stock rallied so sharply last week, but there are a few possible explanations. Unfortunately, those explanations don’t impact the long-term case at all.

One possibility is that it looks like oil prices gained sharply toward the end of the week, at least looking at futures markets. Of course, those ‘gains’ only occurred because oil futures stunningly turned negative on Monday, just ahead of the expiration of the contract for May delivery. The outlook for oil — the majority of Chesapeake revenue after its acquisition of Wildhorse Resource Development — remains dim.

Other investors may have seen the announcement this week of a “poison pill” as bullish. Chesapeake said it wanted to protect some $7.6 billion in net operating loss carryforwards, which can be used to offset taxes on future profits. With the company’s market capitalization now at just 290$ million, those assets don’t appear embedded in the stock price.

The problem there is that Chesapeake has over $9 billion in debt and the deferred tax assets pale in response to that problem. Chesapeake can’t transfer those assets out of the company or to equity holders. With crude at $15 and interest expense running at over $600 million annually, it won’t be posting profits any time soon, either.

Nothing happened last week to change the outlook for Chesapeake. The news still is grim.

Look to the Bond Markets

Indeed, an investor need only look at the bond markets to understand how dire Chesapeake’s financial situation is.

Chesapeake has bonds trading as low as six cents on the dollar. Bear in mind that the equity gets paid after those bonds. Secured bondholders will get some recovery value. Unsecured debt holders will get little at best.

In fact, equity holders almost certainly get wiped out, barring an absolutely astronomical rally in crude prices. And, again, that crude rally isn’t going to come simply when economic activity returns to normal.

The move by the Saudis last month opened the supply floodgates. An agreement on April 13 to cut production garnered headlines. But production will start building again in July.

Natural gas prices have shown some strength, admittedly. But that’s only a small part of the Chesapeake story at this point. There’s simply not enough there to support the $9 billion in debt, as signaled by the bond market. And if the bondholders aren’t getting paid in full, shareholders almost certainly aren’t getting paid at all.

Why CHK Stock Rallied

So why has CHK stock rallied? The simplest answer is that traders are moving the price around.

Such a move wouldn’t be out of character for a stock near bankruptcy — or in it. In fact, fellow oil producer Whiting Petroleum (NYSE:WLL) filed for bankruptcy at the beginning of the month. Its stock gained almost 400% in three sessions last week before a one-third decline on Friday.

It’s not just energy names. One of the more widely-covered bankruptcies in recent years was that of Sears Holdings (OTCMKTS:SHLDQ). When that company declared bankruptcy in October 2018, the stock actually doubled over the following two days.

The rally was erased (and then some) in a week. But traders weren’t done. At the end of 2018, the stock began a 1,000% rally in a month and a half and neared $2. SHLDQ closed Friday at 14 cents.

As far as Chesapeake stock goes, the reverse stock split drastically reduced the share count, and may have resulted in some unusual trading by short sellers covering their positions. But the mechanics of that trading are understood only by experts — and even they can be surprised by these kinds of moves.

Whatever the cause of the recent gains, the fundamental case for investors at this point is clear. CHK stock almost certainly will be worthless, or close, at some point in the not-too-distant future. The odd rally last week doesn’t change that problem.

Time to Move on

To be sure, a Chesapeake restructuring gives me no personal joy. I wish shareholders weren’t getting wiped out. I wish Chesapeake employees weren’t losing their jobs.

But investors can’t make decisions on what they wish would happen. Rather, they need to model, as best as possible, what is most likely to happen. And a company with over $9 billion in debt whose prices are plunging is likely to go bankrupt.

That’s the risk investors take with almost any stock, particularly in the energy space. Diversified majors like Exxon Mobil (NYSE:XOM) or Chevron (NYSE:CVX) are one thing. Leveraged producers are another.

Indeed, the act of looking for oil is called “wildcatting”. It’s not for the faint of heart. Sometimes explorers find a dry hole and go bust.

CHK stock now, unfortunately, is a dry hole. Any investor buying this rally runs a huge risk of going bust.

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.


Article printed from InvestorPlace Media, https://investorplace.com/2020/04/rally-chk-stock-dead-cat-bounce/.

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