Chesapeake Energy vs. Microsoft: Chesapeake

In the competitive spirit of college basketball's annual championship tournament, The Motley Fool brings you Stock Madness 2007! Our writers are making head-to-head arguments for their chosen stocks (but not necessarily investment recommendations -- this is, after all, a game), and you'll pick the winners with your article recommendations and Motley Fool CAPS ratings. Who will win the right to cut down the net? Let's tip things off and find out!

How ironic. After thrashing one $247 billion behemoth, Citigroup, Chesapeake (NYSE: CHK  ) now faces yet another giant -- Redmond, Wash.'s mighty $272 billion Microsoft. I've got nothing against Microsoft, mind you -- it's a current Motley Fool Inside Value recommendation, and I own shares in the company! But this is a competition to find the best team, and the best stock, for your investment money today. That means buying Chesapeake ahead of Microsoft (Nasdaq: MSFT  ) . While Microsoft might be an $0.80-on-the-dollar value, Chesapeake is closer to $0.60.

I laid out my case for Chesapeake in the first round, but I would like to emphasize why Chesapeake stands out in this tournament, and among the many possible investments in the energy, and particularly natural gas, markets:

  • Winning is about teamwork. Chesapeake, led by CEO Aubrey McClendon, wasn't just visionary in its ability to see the coming increases in natural gas prices. It also acted on that vision, acquiring the drilling rights to a huge 10.5 million net acres of prime land.
  • In 2006, the company switched its focus from acquiring land to increasing production and proved reserves through drilling. Last year, proved reserves increased from 7.5 trillion cubic feet equivalent (tcfe) to 9 tcfe. Based on its current drilling program and historical success rates, proved reserves are set to grow by a minimum of 1 tcfe in 2007, and reach at least 11 tcfe -- 11.5, by my estimate -- by the end of 2008.
  • McClendon's team has another string to its bow: the industry's most successful gas hedging program. In 2006, shrewd hedging added $2.41 to the $6.35-per-thousand-cubic-feet-equivalent unhedged price for Chesapeake's gas. While 2006 was an exceptional year for the hedging program, 2007 is already set to add more than $1 to the unhedged price. Volatility in natural gas prices will allow the company to continue its hedging strategy.

Though the market is always focused on the short-term price of natural gas, Fools should concentrate instead on the long-term opportunity. Natural gas prices may be volatile, but they're trending upwards as demand increases. New exploration and production can only keep North American supply treading water. Ultimately, Chesapeake's share price will rise as the market comes to grips with the value inherent in its increased reserves and production capabilities. Lastly, remember that this competition is a no-brainer; Microsoft is 20% undervalued, but Chesapeake is 40% undervalued!

Does this stock deserve to move on to the next round? If you think so, simply head to Motley Fool CAPS and rank the stock "outperform." If not, vote it "underperform." Later this week, we'll tally your votes -- and your article recommendations -- to determine which stocks will advance one step closer to the title.

Read our opposing article on Microsoft, or see all the entries in the tournament.

Think you could pitch your favorite stock -- or ditch your least favorite -- in 27 seconds or less? That's what we're doing over at Motley Fool CAPS. Check out our new stock videos.

Chesapeake Energy and Microsoft are Motley Fool Inside Value selections.

Philip Durell, lead analyst for Inside Value, owns shares in Chesapeake Energy and Microsoft. The Motley Fool has a disclosure policy.


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