For whatever reason, traders began bidding up Chesapeake Energy (NYSE:CHK) earlier this month. I do not believe this was done in an effort to find value in CHK stock, but rather in a bout of speculation.
Investors and momentum traders tried to squeeze the stock higher and succeeded, at least for a few days: CHK shares ripped higher, rallying several hundred percent. Traditional investors looked on in bewilderment as they tried to figure out who would buy a bankruptcy candidate.
On Sunday June 28, Chesapeake began filing for Chapter 11 bankruptcy protection. On Monday morning, the NYSE suspended trading of CHK stock and will commence the delisting procedure.
Although oil prices have surged back to life over the past few months, the rebound simply isn’t enough to save Chesapeake. Struggling to survive even before the novel coronavirus, this company would have had a tough go of things even under near-perfect conditions. Throw in the pandemic chaos and this company barely stood a chance.
Don’t Speculate With Chesapeake
Given the imminent delisting, CHK obviously won’t serve as a trading or investment vehicle. However, Chesapeake Energy can still serve as a cautionary tale in knowing your risk.
When a company is performing reverse splits, that’s a sign that things are likely not going well. Good companies with quality fundamentals undergo regular splits all the time. However, reverse splits are for companies that continue to see their stock price fall, not rise.
Sometimes, a reverse split works out okay. Citigroup (NYSE:C) is one such example. So is Priceline, which changed its name to Booking Holdings (NASDAQ:BKNG) and is up almost 800% over the past 10 years.
So not every reverse split is the end of the world, but it’s something that should get an investor’s attention. In the case of CHK stock, it was a clear warning sign, as were its financials.
The company had way too much liability, carrying long-term debt of more than $9 billion. Against a market cap of just $114 million — granted, after a prolonged slump — this kind of ratio blows any definition of sensible right out of the water.
Current liabilities of $2.2 billion outweigh current assets of $1.8 billion. Of the latter, $762 million was in receivables, with just $82 million in cash and short-term investments. This led to serious concern about whether the company could cover its short-term obligations.
I have been adamant on avoiding CHK stock for months. Those who speculate on such precarious names need to understand the risk they are taking on. Which is to say, you might wake up one morning to shares halted indefinitely, headed for zero.
It’s okay to speculate from time to time, but I prefer to seek out secular growth companies operating in strong themes.
Alternatives to CHK Stock
While there is certainly some value to be found in the energy sector, this group is one to be careful with. There will likely be many small shale companies like CHK stock that end up going under. When they do, they will weigh on the sector’s performance, although it will give other companies an opportunity to scoop up decent assets at a low price.
Does that make these companies a buy? No, not on that merit alone. While I acknowledge that many of these companies will present long-term value to investors, the sector is currently in a very difficult environment.
Not only does the energy sector face a difficult road ahead thanks to the elevated volatility in the stock market, but it also faces the difficult shift in day-to-day life wrought by Covid-19. Most companies have to navigate shutdowns and other such disruptions too, but energy stocks have to navigate the energy markets besides.
Swoons in oil and natural gas prices will have an impact. With producers ready to pump at will, supply will continue to limit upside in energy prices. Unfortunately, that’s likely to make growth difficult for this group.
Investors who are still attracted to energy stocks should stick to those with strong balance sheets. They will weather the storm and see a brighter future.
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.