This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
What do you do when one of the best investors on the market up and downgrades one of your own favorite stocks -- and a stock that by all indications on CAPS, should be a winner? Do you follow the analyst's lead and sell, or do you use the fact that everyone else is selling as your chance to "get in" at a good price?

That's the dilemma that faces Chesapeake Energy (NYSE: CHK  ) investors this week. Yesterday, Argus Research -- a top-10%-ranked analyst here on CAPS -- announced that it's slapping a sell rating on Chesapeake. This probably comes as a shock to Fools who know the company: After all, Chesapeake gets a five-star rating on CAPS, and an official recommendation of the Fool's own Motley Fool Inside Value newsletter. So why is it that Argus hates it so much?

Here's how
Hate. Perhaps that's too strong a word. Fact is, Argus actually likes Chesapeake in some ways, praising the company for having collected "one of the industry's best collections of natural gas assets." Then again, it's not Chesapeake's assets that are the problem -- it's the price the company paid for 'em, and the money it's spending to expand these assets further.

Noting that Chesapeake had previously assured investors it had eaten all it could hold, and was ending its "land grab" for natural gas assets, Argus takes issue with the company's recent about-face. Chesapeake has already spent $3.7 billion acquiring natural gas and oil assets so far this year, Argus says, grumbling -- but it still can't stop spending. No sooner had the company signed a deal with CNOOC (NYSE: CEO  ) to help fund development of its Eagle Ford assets in Texas, than Chesapeake turned around and bought $850 million worth of oil and gas assets in the Appalachians.

Argus terms Chesapeake's spending spree "profligate" and worries about the toll it's taking on the company's balance sheet -- and so do I.

Hey! Me, too!
Fools, I take no pride in being a "me-too-er" on Chesapeake. I'm even a bit nervous, finding myself in agreement with the likes of Argus, which, for all that it's a decent analyst in other industries, has a rather spotty track record in the oil patch:

Companies

 

Argus' Rating

CAPS Rating

Argus' Picks Beating (Lagging) S&P by

BP (NYSE: BP  ) Outperform *** 2 points
Kinder Morgan Energy (NYSE: KMP  ) Outperform ***** (13 points)
Chevron (NYSE: CVX  ) Outperform **** (21 points)
ExxonMobil (NYSE: XOM  ) Outperform **** (50 points)

Over the four-plus years we've been tracking the analyst's performance, Argus has racked up the unenviable score of just 39% accuracy on oil and gas stocks, a big blemish on its otherwise-respectable record of 51.5% accuracy overall in the market.

But facts is facts, and the plain fact of the matter is that Argus is right about Chesapeake. The company is spending too much on its assets. It is destroying shareholder value. And yes, Argus is even right on the rating -- you really should consider selling Chesapeake.

Cash isn't trash
Why? Because as much as Chesapeake recognizes the value of oil and gas assets, it simply doesn't have enough respect for the value of money. Cash isn't trash, and there's just no excuse for burning it at the rate Chesapeake does. Over the past five years -- during most of which Chesapeake claimed to be earning "profits" -- this company has in fact managed to burn cash at the rate of roughly $1.3 billion per year. Over the past year, cash-burn has accelerated to nearly $3.5 billion -- at the same time as management cited GAAP accounting standards in support of its claim to have "earned" $1 billion.

Foolish final thought
Chesapeake bulls will of course argue that this cash-burn is necessary. That it's even a good thing, as it builds the company into a force to contend with in the oil patch. Don't believe 'em. ExxonMobil, Chevron, ConocoPhillips (NYSE: COP  ) , BP -- essentially all of Chesapeake's main rivals in this industry manage to do just fine without burning cash. Why, even Anadarko Petroleum usually manages to keep its cash flow statement in the black (if only just barely).

I see no reason why investors should have to submit to being the odd man out in this club. No reason to own Chesapeake, when there are so many better stewards of shareholder cash out there to choose from.

Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he was recently ranked No. 605 out of more than 170,000 members. The Motley Fool has a disclosure policy.

Chesapeake Energy is a Motley Fool Inside Value selection. Chevron is a Motley Fool Income Investor selection. The Fool owns shares of ExxonMobil.

Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 02, 2010, at 12:00 PM, NHWeston102 wrote:

    I heartily agree! I wrote a comment several months ago stating the same thing much less incisively. The CHK management team just seems to be missing a few bricks in their chimney. They buy assets, then sell them, usually at a loss - so the bull case that they are amassing a grand collection of estates just doesn't wash to me. It's more like they are just, well, thrashing like a beached whale! And, again, that whole business a while back of buying an antique maps collection to help the boss out of his bad margin calls...how is that in shareholder interest? At all? That's not management, that's a frat-pack cabal. I know Cramer wiggles and giggles about CHK and shies from all other Nat Gas companies, but I'm still not convinced. I also hear they have a lot of debt and they're not paying it down. That sounds more like the home-builders than an energy company. Wanna speculate, try SD or Oasis or, better yet, NOG. Rich, I think you're right - there are better horses out there.

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