Energy stocks have caught a bit of bounce, and Chesapeake Energy (NYSE:CHK) has been one of the beneficiaries. The optimism toward the sector makes some sense. The rally in CHK stock, not so much.
After all, the oil market is showing signs of recovery. Futures contracts briefly went negative in April as the world basically ran out of storage for crude. But as the economy moves toward reopening, some semblance of normalcy has returned. Oil futures in fact hit a three-month high this week.
The same optimism toward normalcy is boosting energy stocks. Exxon Mobil (NYSE:XOM) has rallied 64% after touching a 16-year low in March. Rival Chevron (NYSE:CVX) has bounced 88%. The sector as a whole, as measured by the Energy Select Sector SPDR Fund (NYSEARCA:XLE), is doing about as well, with an 82% rebound.
CHK stock itself has benefited. Though the multi-year chart remains hideous, it shows a bit of a bottom at the moment. Shares have bounced 50% from the May 14 close.
But that bounce is exceedingly unlikely to hold. The optimism toward the sector makes some sense. The problem for Chesapeake Energy, however, is that even a bit of optimism isn’t close to enough.
Bankruptcy Vs. Insolvency?
It is highly likely at this point that Chesapeake Energy is going to file for bankruptcy. In conjunction with first-quarter results last month, the company for the second time disclosed a so-called “going concern” warning.
It’s worth understanding, from a high-level perspective, what bankruptcy means. It doesn’t mean the business is worth nothing. Indeed, Chesapeake owns oil- and gas-producing properties that have value.
Rather, to oversimplify the situation, bankruptcy usually means that the assets are worth less than the debt. Put another way, at least in this situation, the company is insolvent. There are times that a solvent business might file for bankruptcy, but those situations are unusual.
Chesapeake Energy appears to be insolvent. The company finished the first quarter with over $9 billion in debt. Its assets simply aren’t worth that much.
The Numbers Don’t Work
Indeed, the company’s own analysis suggests as such. In its Form 10-K filed with the U.S. Securities and Exchange Commission in February, Chesapeake disclosed its so-called “PV-10.” That figure estimates the net present value of future cash flows from Chesapeake properties.
The analysis suggested the properties were worth about $9 billion — roughly the same amount as the debt at the end of Q1. But there’s a big catch. That analysis was done using crude prices of $55.69, and assuming natural gas at $2.58. Current prices are below $40 and under $2, respectively.
Run that analysis under the updated assumptions and Chesapeake’s value falls literally billions of dollars below the amount of its debt. And that doesn’t even include significant factors like corporate spending beyond simple production and transportation costs.
The math does not work. And a move in crude from $35 to $45 or even $50 doesn’t change that problem.
The debt markets know this. There are Chesapeake bonds trading at as little as one penny on the dollar. Those bondholders have a claim on the assets before shareholders — and that claim is being treated as essentially worthless by the bond market.
Please Don’t Chase CHK Stock
Despite that problem, Chesapeake Energy still has a market capitalization of $128 million. Again, the stock has bounced. It may bounce further still.
Indeed, CHK has seen big rallies in the not-too-distant past. It tripled in a matter of sessions in April. It doubled in February.
And as I detailed in discussing J.C. Penney (OTCMKTS:JCPNQ), traders like to play with bankrupt names. Hertz (NYSE:HTZ) has been all over the place since it filed last month. Sears Holdings (OTCMKTS:SHLDQ) still sees volume.
But hopefully, most of those traders understand that those stocks are just vehicles for volatility. They’re not long-term investments. Sears isn’t coming back. Hertz will wind up owned and operated by its bondholders, or whichever entity to which those creditors sell the business.
Chesapeake will exist in some form as well. Fellow Oklahoma City energy giant SandRidge Energy (NYSE:SD) emerged from bankruptcy a few years back. I expect Chesapeake will do the same.
But that “new” Chesapeake will be a different company. It will have different owners. And through that process, current shareholders are exceedingly likely to get wiped out. Normalcy in the crude market doesn’t change that fact. Nothing short of an absolute miracle can.
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.