Chesapeake Energy (NYSE:CHK) said there is “substantial doubt” it will continue as a going concern, in its latest SEC 10-Q filed on May 11. That is a warning about CHK stock, directly from the company, for investors.
I have discussed this in my earlier articles. In early May, I wrote that the stock is now worthless, as it is likely to enter bankruptcy. Well, guess what. Note 2 in the latest required quarterly filing with the SEC, the company said that it has hired advisors to assist it in evaluating its strategic options.
This includes the following potentials actions:
“but may not be limited to, seeking a restructuring, amendment, or refinancing of existing debt through a private restructuring or reorganization under Chapter 11 of the Bankruptcy Code.”
Five Years and $21 Billion Lost
Chesapeake blames the situation on “volatility” in oil and gas prices and the OPEC decision to flood the market with supply. But the truth is the company is drowning in debt. In addition, it has not been operating a profitable business for quite some time.
For example, in the past five years, Chesapeake has been profitable only once, for just $133 million. Put another way, Chesapeake has lost a cumulative $20.57 billion, on a net income basis in the past five years.
From a cash flow standpoint, the situation is just as bad. For the past five years, the company has produced annual negative free cash flow, after capital expenditures. This has totaled over $7.5 billion, evident in the chart at the right.
Cash flow from operations (CFFO) is negative FCF each year due to the company’s capex spending. FCF is equal to CFFO minus capex spending.
In fact, in each of the past five quarters, the previous 12 months’ FCF has been negative. Chesapeake has lost between $435 million and $635 million in FCF over the last 12 months for the past five quarters, evident in the chart at below right.
The point is that the company simply cannot produce positive free cash flow, mainly because it has not reduced its capex spending. In effect, it uses up all the cash flow it produces and more just to drill more wells.
The problem has been that the price of oil and gas has been falling. So this sent the company into a spiral of higher capex spending just to produce more cash flow which it couldn’t finance.
Untenable Debt Pile
This has resulted in an unprecedented pile of debt. The company simply can’t produce enough cash flow to pay back the debt.
For example, as of March 31, 2020, Chesapeake had over $9.5 billion in total short-term and long-term debt. The company had just $82 million in cash. Its shareholders’ equity was negative $3.9 billion.
Moreover, the company has $2.26 billion in current liabilities which must be paid within the next 12 months. This includes $420 million in debt maturities this year. The company has little ability to pay what’s coming due.
For example, although cash flow from operations in Q1 was positive $397 million, the company spent $512 million in drilling and other capex spending. So its FCF, which is what is used to pay back debt, was negative $115 million.
How is the company going to pay back this debt this year? There would have to be either higher oil and gas prices, which would make FCF positive, or the Chesapeake enters into a debt restructuring in Chapter 11.
The problem is that Chesapeake cannot let up on its drilling and capex spending. As one analyst Daniel Jones put it in an article on Seeking Alpha, Chesapeake has always had very high capex requirements. This was just in order for the company to maintain flat production.
What to do With CHK Stock?
If you read the 10-Q from Chesapeake you can’t help but feel that this is a company, in its current form, on its last legs. The likelihood of a debt restructuring that wipes out all shareholder value is high.
Investors should steer clear of CHK stock until it is evident what is going to happen. Even the company is now warning there is substantial doubt it will be a going concern.
If you believe that higher oil and gas prices will save the company, you are taking an extremely high degree of speculative risk. There simply isn’t any margin of safety in this stock.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.