In late June, after weeks of speculation, Chesapeake Energy (OTCMKTS:CHKAQ) finally officially filed for Chapter 11 bankruptcy, which allows a company to operate and work out deals with creditors while effectively wiping out common equity holders. Things don’t look great for CHK stock.
On June 29, the New York Stock Exchange (NYSE) suspended the company and de-listed shares. Since then, the company has moved to the over-the-counter market and is still trading publicly.
However, the Chesapeake stock is likely to remain highly volatile and long-term investors should not buy the shares.
Bankruptcy Expectations and CHK Stock
The Oklahoma-based company voluntarily filed for Chapter 11 to facilitate a comprehensive balance sheet restructuring. It may be tempting to blame the effects of the pandemic and volatility in oil prices in 2020 for the demise of the company, its woes had started some time ago.
The group was founded in 1989 and went public in 1992. Chesapeake Energy was number 309 on the 2019 Fortune 500 list. It was included in the S&P 500 Mid-Cap index until late February.
When the pandemic hit our shores and the oil crisis started in March, CHK stock was already in a fundamentally compromised situation. It had $9 billion in debt.
Over the past decade, management had bet aggressively on America’s natural gas boom. However, it had failed to account for the decline in the price of gas down mostly as a result of fracking.
In 2016, there had been rumors of a potential bankruptcy filing, too. But it had managed to pull through those difficult days. At the time, research published by David Larcker and Brian Tayan of Stanford University highlighted poor corporate governance at the firm.
Analysts have been warning about the extremely high levels of debt for quite some time. By the beginning of 2020, the price of oil was around $60 a barrel, which already had made it difficult for Chesapeake Energy to service its debt.
Then as oil and gas prices went into free fall in March, Chesapeake’s cash flow decreased. And the end became inevitable.
On April 13, the group announced 1-for-200 reverse stock split, stating: “The reverse stock split is intended to, among other things, increase the per share trading price of the Company’s common shares to satisfy the $1.00 minimum bid price requirement for continued listing on the NYSE.”
In other words, without such a move, CHK stock would have been delisted in April. And CFRA analyst Paige Meyer tagged the stock with a “strong sell” rating and a $0 price target.
What Bankruptcy Means for Chesapeake Stock
Recent research led by Monika K. Sywak of Villanova University highlights, “equity is the last in line to receive what’s available to be distributed in a bankruptcy proceeding. Ahead of the common stockholders in line, are secured lenders, suppliers, employees and even unsecured creditors. Even if a company successfully reorganizes, the future of common stock is very uncertain.”
Seasoned investors realize that such a bankruptcy filing will make Chesapeake stock worthless. The U.S. Securities and Exchange Commission (SEC) clarifies what happens when a public company files for protection under the federal bankruptcy laws.
It says “Bankruptcy laws determine the order of payment… Stockholders – owners of the company, have the last claim on assets and may not receive anything if the Secured and Unsecured Creditors’ claims are not fully repaid.”
However, the past few months have seen many retail investors betting on bankrupt companies’ stocks. Other names that day traders have been flocking include Hertz Global (NYSE:HTZ), JCPenney (OTCMKTS:JCPNQ) and Whiting Petroleum (NYSE:WLL).
In an article titled “Gambling on the Stock Market: The Case of Bankrupt Companies,” Luis Coelho and Richard Taffler of Warwick Business School conclude that retail investors trade more extensively on the stock of bankrupt firms than sophisticated investors do. They highlight “individual investors own, on average, 90% of the stock of firms undergoing Chapter 11 reorganization.”
It is possible to say that most of them are simply betting on it like a lottery ticket. Believing Chesapeake stock is due for better days is daydreaming.
The Bottom Line on Chesapeake Stock
Most companies go bankrupt because they cannot pay their bills. Investing in bankrupt names like Chesapeake stock in effect means wagering against a legal process that wipes out shareholders.
So it is not investing, but sheer reckless speculation. If you decide to play that daily game, it is important to appreciate the risks involved fully.
Market participants see price spikes in any one of these bankrupt names quite regularly. However, long-term investors would be best served if they did not include any of them in their portfolios.
If you are a rather risk-averse investor who wants to invest for the long run, broader markets offer plenty of solid companies.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, including a Ph.D. degree, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. As of this writing, Tezcan did not hold a position in any of the aforementioned securities.