Is This Chesapeake Energy Director Telling You to Buy?

Famed money manager Peter Lynch told us that executives can sell their stock for any reason, but typically can buy only for one: They think the price is going to go up!

Today I'm highlighting oil and natural gas driller Chesapeake Energy (NYSE: CHK  ) , which saw one of its directors buy some $1.5 million worth of stock over the past week even though shares have climbed more than 46% since their low point in May. These aren't option grants either, but purchases made on the open market just like you and me.

Chesapeake Energy snapshot

Market Cap

$12.9 billion

Revenues, TTM

$12.5 billion

1-Yr. Stock Return

(27.4%)

Return on Investment

7.0%

Est. 5-Yr. EPS Growth

7.8%

Dividend & Yield

$0.35/1.8%

Recent Price

$19.36

CAPS Rating

****

Source: FinViz.com

Although following the lead of insiders can be profitable, I still recommend you do further due diligence to determine whether this stock would make a good addition to your own portfolio. So this isn't a call to buy, but just the inside track on a company you might want to check out further.

Texas hold 'em
Energy stocks tend to be cyclical, but as my colleague Nicole Seghetti has pointed out, that's not always the case, and during the latest market run-up the sector has lagged. That's likely because a rising market is often the herald of an expanding economy, but today the indexes are running higher as a result of Federal Reserve monetary policies pumping extreme levels of liquidity into the market.

That's hopeful for the sector, since it's not so much the industry that's the problem, but government policy that's out of whack. But, that's not a blanket statement. In particular, Chesapeake Energy still has to contend with its CEO Aubrey McClendon, who, while engaging in less than savory business transactions for his own benefit, apparently still views the energy producer as his personal fiefdom.

Growth through divestiture
McClendon also operates the business like a reckless high-stakes gambler manages his stake; Chesapeake essentially going all-in on every bet. It's won some big jackpots with its assets sales, selling quality plays in the Permian Basin to Chevron (NYSE: CVX  ) and Royal Dutch Shell (NYSE: RDS-B  ) and raising some $13 billion in the process. It also sold some of its pipeline assets; in fact, had it not been for shedding its assets it might not have been able to meet its debt obligations -- the result of another risky bet on being able to take on mountains of liabilities.

It's also spun off several royalty trusts, the Chesapeake Granite Wash Trust (NYSE: CHKR  ) and the Chesapeake Lodging Trust, that allowed it to generate fistfuls of cash for its assets without diluting current shareholders with new stock or burdening itself with debt.

But, selling off prime real estate is really a stopgap measure -- a company can employ the strategy only for so long. It's got some breathing space now, but it needs to focus on future operations. And that future is as a liquids player since it's sworn off the dry gas business. It plans to grow that segment of operations from the 10% of its assets it commanded in 2010 to 35% by 2015.

Showing your cards
The liquids market has enjoyed higher margins than the dry market, but Chesapeake isn't alone in chasing those higher profits. GMX Resources, Cimarex Energy, and Encana (NYSE: ECA  ) are all making the switch toward liquids production and away from dry gas, meaning margins are likely to start slipping.

While Chesapeake has said the switch to the booming liquids market will be only until dry gas stabilizes and improves, the energy producer may have swung the pendulum too far to benefit from a recovery, if and when it does occur.

Of course, some analysts say that's likely to be a long time coming. Some analysts believe it's going to be decades before gas prices rise above $4, and our grandkids will be collecting Social Security before it hits $8.

At just six times earnings Chesapeake looks cheap, but its CEO is a wild card that's tough to bet with. The energy producer has hardly ever been cash flow positive, and while it says it's looking for 2014 to be the year that changes, I've gone and rated the oil and gas driller to underperform the broad market indexes on Motley Fool CAPS. You can tell me in the comments box below whether you agree a top executive heedless of the risks he poses to his business makes Chesapeake Energy a high-risk gamble that's likely going to crap out before hitting it big.

On the inside track
Chesapeake does have potential, which is why Carl Icahn has been building his stake in the energy play, but why not invest in the one company in the energy sector that can hold fast no matter what oil or gas goes for? Find out why this company is the only energy stock you'll ever need in the Motley Fool's popular free report. Click here for the inside scoop while it lasts.

Fool contributor Rich Duprey holds no position in any company mentioned. Click here to see his holdings and a short bio. Motley Fool newsletter services have recommended buying shares of Chevron. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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