Will Financial Discipline Help This Energy Company?

After amassing a very large debt position, Chesapeake Energy (NYSE: CHK  ) decided it was time to be conservative. Chesapeake began to cut its leverage by selling some of its assets. In addition to that, the company focused on growing its oil production, as natural gas prices remained low. These measures helped Chesapeake gain as much as 57% this year. However, the future of the company is still unclear.

Oil production will fall in the fourth quarter
Chesapeake stated that it expects fourth quarter oil production to drop by 9,000 barrels a day. As growing oil production was one of the main sources of investor confidence, this announcement was not a positive for the company.

Chesapeake mentioned several reasons for this drop. First, the company stated that third-quarter production in the Eagle Ford was above the normal rate. Second, several oil-producing assets were sold. Third, heavy rains in South Texas in October affected Eagle Ford production rates.

Less oil production is clearly bad for Chesapeake. The market favors liquids-rich players like EOG Resources (NYSE: EOG  ) , which is the largest leaseholder in the Eagle Ford with 639,000 net acres. EOG is also the largest Eagle Ford producer with 460 net wells. What's important given the low natural gas prices, oil is 78% of EOG's total production. Despite the fact that EOG is up 42% this year, it still trades at a decent 18x forward P/E.

Chesapeake might be willing to follow the path of Cabot Oil & Gas (NYSE: COG  ) , which complements its 200,000 net acres dry gas position in the Marcellus Shale with 62,000 net acres in the Eagle Ford. Cabot added a second rig to its Eagle Ford program in August.

The debt problem remains
Now let's turn to Chesapeake's main problem – its $12.7 billion debt. The company sold assets for $4.2 billion so far this year, but it will have to sell more. Chesapeake boasts that it has $5.2 billion of liquidity, but if we dig deeper, we find that $4.2 billion of this liquidity consists of undrawn credit revolvers.

The company is sure it will not have to engage in any kind of a fire sale of its assets. However, Chesapeake will have to pay $1.66 billion of debt as soon as 2015. This payment will be followed by a $500 million payment in 2016 and a huge $4.3 billion payment in 2017.

I think that it's the 2017 payment that investors should focus on. Time is running out fast, and, currently, Chesapeake does not have an investment grade rating. This means higher rates should the company choose to refinance its debt.

Chesapeake states that it does not have to issue new equity. The most important point is the fact that it does not have to do it now. Share dilution is almost always bad news if the proceeds are going toward debt repayment instead of growth projects.

Bottom line
Chesapeake trades at a reasonably attractive 12x forward P/E, but the company has significant long-term risks. Recent developments were good, but they might be already priced in. It will be a difficult task to grow production when the company has to sell assets. The situation with production at the Eagle Ford is an example of such risk. Investors should also keep in mind the possibility of share dilution.

All in all, I believe that Chesapeake must demonstrate more improvements to become a conviction buy. 

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  • Report this Comment On November 12, 2013, at 1:35 PM, speculawyer wrote:

    The Red Queen syndrome is catching up to them.

  • Report this Comment On November 12, 2013, at 3:48 PM, kmacattack wrote:

    I have to respectfully disagree with Vladimir. I've been long in Chesapeake for the past 5 years. The author's focus is based on Chesapeake's Eagle Ford OIL production. Chesapeake is STILL the 2nd largest natural gas producer in the US, behind Exxon. Natural gas prices aren't GREAT right now compared to historical highs, but Nat Gas has DOUBLED from the lows in the $1.80 range a couple of years ago. Chesapeake is one of the lowest cost producers in the US of Natural Gas. From what I have read, their production cost is about $2.50 per mcf. Nat gas has been bouncing around from $3.50 to $4.25 or so for the past few months. Demand for Natural Gas is going to be headed nowhere but up in the future for a number of reasons.

    Despite the manipulation of the market by David and Charles Koch, the Koch Brothers are not going to be able to catch the natural gas genie and put it back in the bottle.

    In 2009, Shortly after Obama was sworn in, the Pre-Tea Party House of representatives passed what was widely hailed even in the Wall Street Journal as the "best piece of legislation passed" since the 1960's."

    The bill was the American Power Act, which was designed to END America's OPEC oil imports within 5 years and go "all in" on American made natural gas by encouraging construction of a nationwide Natural Gas Superhighway. This would make it possible for the nation's trucking fleet to convert from dirty burning OPEC sourced Diesel to 100% American made Compressed and Liquid Natural Gas. We are sending $3 TRILLION per year in cash from the US to OPEC, and a portion of that money is used to finance Terrorist Groups such as Al Qaeda. Natural gas fuel will sell on average for about HALF the price of Diesel, so not only will about $3 Trillion go back into OUR economy (4 Times the amount "spent" on Stimulus since 2009), but HALF that amount is pure "lost profit" when the money is sent to OPEC. The bill was written by two former Arch enemies, Sen John Kerry and the man most responsible for his narrow loss in 2004 to "W" Bush, T. Boone Pickens. Pickens and Chesapeake's Aubrey McClendon financed the illegal election eve "Swiftboat Documentary" run on every Taft Broadcasting station in the nation, which flipped Ohio from Kerry to Bush, and thus "elected" Bush. I've since gained respect for both men for putting partisan differences aside and trying to do what was BEST For the COUNTRY. After the solid bi partisan majority of over 280 votes passed the Energy Bill, the Kochs set their sites on blocking the bill in the Senate. Mitch McConnell stalled the bill for 2 more years when at one time, Harry Reid had enough republicans lined up to vote with all but two democrats (from oil producing states) to reach 60 votes and kill McConnell's One man filibuster. When Ted Kennedy died, support dropped to 59 votes "for" and all that was needed to kill it was McConnell's statement that he would filibuster it. Over the next two years, McConnell filibustered a watered down bill twice more, while he took $550,000 in "contributions" from Big Oil, the Koch brotehrs, and the Coal Lobby, who all have a financial interest in our continued dependence on OPEC oil vs. US made Natural gas. The Kochs thus killed demand for natural gas, which allowed gasoline prices to hit $4.00 per gallon which temporarily stalled the recovery. The Kochs not only make Billions from their inherited refining business which would be hurt with conversion to natural gas, but they control a huge share of chemical and fertilizer production. Both these industries use huge quantities of natural gas, and we have not seen chemical or fertilizer prices drop because oil and natural gas prices crashed by about 75%. The 2 Kochs are now worth $50 Billion, in a virtual tie with Bill Gates. They own politicians clear down to the state and local level. Fred Koch, Charles and David's father was a "founding father" of the John Birch Society in 1958. The "Tea Party" is largely financed by the Kochs. Ultra Conservative William F. Buckley, editor of the National Review warned the country 40 years ago to NEVER ALLOW the "radical and dangerous" John Birch Society to gain access to the government, and today, they have been able to take the money STOLEN from the American people through market manipulation and finance their own "grassroots" party. Thanks to the Kochs, another $15 Trillion has been shipped to OPEC in the last 5 years. The good news is, though, that the Kochs were unable to stop construction of the natural gas superhighway. Chesapeake and 2 other large gas producers loaned Clean Energy Fuels the $450 Million needed to build 450 natural gas fill stations on the nation's Interstate highway system, and the system is now about 65% complete. Large fleet users such as UPS, Waste Management, etc. are ordering Natural Gas fueled trucks by the thousands. When huge fleets such as Wal Mart's thousands of trucks convert, and they WILL, demand for natural gas will increase dramatically. There are no more coal fired, nor nuclear powerplants being built. Coal fired plants are being converted to natural gas every day. Natural gas is by far the cleanest fossil fuel, producing 1/4 the CO2 of coal and diesel, plus no sulfur. In this state, CNG is readily available at about $0.79 per gallon. Chesapeake is supposed to be developing a natural gas fuel compressor with Whirlpool, which fits in your garage and you can fill up at home. ONEOK tells me the cost for home filling is currently $0.56 per gallon. Chesapeake was reportedly building a refinery in Lousiana which will make low cost gasoline out of natural gas. They were also working on a retro fit kit for long haul trucks which would not require the engine to be changed out, and would allow the truck to run on CNG, LNG, or Diesel, or a blend. I would recommend that the author do some research into this information which was all contained in last year's annual report in Aubrey McClendon's letter to shareholders. When Aubrey was CEO and Chairman (which should not happen again) he gambled not only his money but billions of shareholder's dollars on stable to rising natural gas prices. Aubrey was blindsided by the Koch Brothers manipulation. Without the Koch's blockage of the Energy Bill and later the "Natural Gas Act" Chesapeake would be selling above $70 per share today. More importantly, this year, America would have imported our last barrel of OPEC oil. In spite of the Koch brothers best efforts, Natural Gas fuel is becoming a REALITY. When natural gas prices reached an all time high in 2007 of $14 per MCF, CNG fuel was still selling for HALF the price of gasoline, which had moved up to $5.00 per gallon, and was largely responsible for fueling "The Great Recession."

  • Report this Comment On November 12, 2013, at 4:32 PM, kmacattack wrote:

    Vladimir, I think your article is very short sighted. You focused solely on Chesapeake's holdings in the Eagle Ford formation. This is but a small portion of Chesapeake's holdings. I wrote a long reply which has not yet posted, but I'll just add what the people I pay close attention to are predicting for Chesapeake over the next year. :

    Wall Street analysts say by a count of 30 to 3 that Chesapeake will "Outperform" the market.

    But that's not who I was talkng about so much as the Motley Fool Caps community. Read this and WEEP. Of the Caps community, the count is 7,366 to 232 sentiment (about 97% positive), the overall caps Community predicts Chesapeake will Outperform. Of the ALL Stars, the CAPS who have the very best "picking" records" the figures are 1,219 to 35 in favor of Chesapeake OUTPERFORMING the broad market, slightly MORE than 97% positive. The stock is rated 4 Star by the community, next to the very best 5 star rating, up from 1 star a couple of years ago. The P/E ratio you quote is about 12, but Motley says it's 18.99, not as good as your P/E, but a HUGE Improvement from 2 years ago. The Natural gas superhighway was blocked by the Koch brothers and Mitch McConnell's 3 filibusters from 2009 through 2012 . This obstruction continued to force America to send $3 TRILLION per year to OPEC when conversion of Americas trucking fleet would have ended all OPEC imports by this year. OPEC and friends, the Kochs, and the Big Oil Mafia stand to lose Trillions of dollars if they have to compete with Natural Gas fuel. The Coal producers have lost all new powerplant construction to natural gas technology, and existing coal fired plants are converting every day. The obstruction of the American Power Act drove natural gas down to $1.80 per mcf., which nearly bankrupted Chesapeake, Sandridge and several other large natural gas producers, but in the last 2 years, natural gas prices have doubled to profitable levels for low cost producers like Chesapeake. The Kochs made tens of billions at the expense of American consumers who have been forced to pay up to $5 per gallon for gasoline, and near $6 for Diesel. The Kochs inherited refineries and made a fortune refining gasoline and diesel. They made even more money by crashing the nat gas market because of the huge amount they consume in their production of chemicals and fertilizer. I just paid $18 per bag for fertilizer which cost $3 not that long ago. We've seen no drop in petro chemical prices at all since prices dropped from $150 down to $35 in 2008. A quart of motor oil which was $1 a few years ago is about $5 today. The same is true for products like liquid wrench, WD 40, transmission fluid, etc. However, Chesapeake and 2 other large natural gas producers loaned Clean Energy Fuels the $450 Million needed to build out he natural gas superhighway, and it's about 65% complete already. Large fleets are starting to convert to natural gas fuel. I'll predict that within 2 years, Wal Mart will be running their entire fleet on natural gas fuel, because they know that by doing so, they will save BILLIONS of dollars per year in fuel costs.The future of fossil fuels in in natural gas, and Chesapeake is placed to lead the US into the future.

    OPEC will be irrelevant. Wars will no longer need be fought for control of oil supplies.

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