Can Chesapeake Energy Become the Next ExxonMobil?

"As a reminder, our new strategy has two fundamental tenets: first, financial discipline, and second, profitable and efficient growth from captured resources."
--  Doug Lawler

This is a significant departure from the strategy of Chesapeake Energy  (NYSE: CHK  ) founder and former CEO Aubrey McClendon, who followed a maverick "land grab" style of accelerated growth. Many of his bold moves required significant leverage, and the massive drop in the price of natural gas that started in 2011 and carried through most of 2012 left the company on the brink of ruin. Add in McClendon's own personal business and investment dealings -- which many investors saw as creating conflicts for McClendon to act in Chesapeake's best interest -- and in June 2012, he was out as chairman. In April of this year, he retired as CEO as the rift with a mostly new board widened, opening the door for the company to begin moving in a new direction. 

Now the company is focused on deleveraging, profitable, disciplined growth, and investing resources in ways that will maximize profits and cash flow, not just growth for the sake of growth. Will this new approach -- a la ExxonMobil  (NYSE: XOM  ) -- net the best return for shareholders, or will investors miss McClendon's "damn the torpedoes, growth at any price" approach? Let's take a closer look.

The king of ROCE
Much has been made lately of how effective ExxonMobil is at making use of its capital. Its industry-leading return on capital employed, or ROCE, isn't just a recent trend. The company has been effectively leveraging its capital for years, ranking at or near the industry top since CEO Rex Tillerson took the reins in 2004:


XOM Return on Capital Employed (TTM) Chart
XOM Return on Capital Employed (TTM) data by YCharts

While putting Chesapeake up against diversified majors like those above isn't really a fair comparison, the chart does tell us two things: 

  • ExxonMobil is excellent at deploying capital effectively.
  • The worst-case scenario of a recession, historically low natural gas prices, and McClendon's mismanagement of Chesapeake combined for horrible returns on capital -- making it understandable why investors and the board chose a CEO, who is now taking the company in a different direction.

Which is where we are today
Doug Lawler and team have done a great job since Lawler took over in May of this year by taking a more ExxonMobil-esque approach to the business. While the initial path was laid by former COO and interim CEO Steven Dixon, and largely driven by the board of directors, it has been Lawler, who has altered the management team since taking over, including replacing Dixon, a 20+ year veteran of Chesapeake, as well as two vice presidents and the head of HR.

The real changes with the company's direction started with the board of directors, which features only one member who has been around since before 2012: Pete Miller, CEO of oilfield services and equipment behemoth National Oilwell Varco  (NYSE: NOV  ) . 

In 2012, the company sold $12 billion in land assets held using "hold-by-production," which often meant the company was losing money to retain assets. Transitioning to pad drilling and utilizing newer rig technology that allows rigs to be more easily moved from one well head to the next, Chesapeake is focusing on the "core of the core" and maximizing returns on its best assets, instead of spreading out to retain land it may be years from being able to develop. 

Through Q3, the company had sold $3.6 billion in assets, with another $600 million to close in Q4 -- at the low end of the $4 billion to $7 billion targeted for 2013 in the 2012 annual report. Additionally, the company repurchased $1.89 billion in senior notes, reducing interest expense. Combined, the asset sales and reduced debt will give the company lower fixed expense moving forward. Lawler has also stated that the company will reduce capital spending in 2014, but increased focus on maximizing resources would net organic growth.

National Oilwell's influence
Pete Miller's hand is also likely at work here. The long-standing head of National Oilwell Varco understands the value of maximizing the return on invested capital and fiscal discipline. Since taking over at National Oilwell in 2002, the company has made money every single quarter, and grown net income by more than 2,000%, and total shareholder returns are over 540%, more than 440% better than the S&P 500 over the same time frame. National Oilwell has become commonly referred to as "No Other Vendor," aptly describing how integrated it has become as a key supplier to every major oil company in every geography in the world. 

Final thoughts: The slow and steady power of discipline
XOM Total Return Price Chart

XOM Total Return Price data by YCharts

As the chart above shows, even a behemoth like ExxonMobil can pay strong returns, having outperformed Chesapeake as an investment since 2004, even as Chesapeake grew significantly faster. Largely due to using stock as currency, while ExxonMobil has significantly reduced shares outstanding, Chesapeake investors never really saw the maximum potential that the company offered under McClendon's maverick approach to growth. Add in the influence of National Oilwell's Pete Miller, whose company has seen shares increase based on several large acquisitions, but never overleveraged the company, and there is more reason to like what's happening at Chesapeake today. 

Will Lawler and the new board's change of strategy net better returns over the next decade? If ExxonMobil is an example of how the method can work, there's a good chance it will.

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