Is Chesapeake’s 2014 Outlook Really That Grim?

Is Chesapeake’s 2014 outlook as grim as traders and investors have made it out to be? Let’s examine the company’s 2014 production and capital expenditure projections.

Feb 13, 2014 at 8:31AM

Chesapeake Energy (NYSE:CHK) recently revealed its 2014 outlook. This outlook was worse than investors had anticipated and resulted in an over 8% fall in the company's stock since the beginning of the month. Is the outlook really weak enough to warrant the recent selling? Let's examine the company's expected changes in production and capital expenditure for 2014 to better understand.

Production outlook
During 2013, Chesapeake boosted its oil production and cut down its natural gas output. In 2014  the company expects to keep moving in this direction. Its natural gas production is projected to decline by an average of 1%, year over year. Thus, its total natural gas output will reach, on average, 1,070 Bcf. Conversely, its oil production is expected to rise by 3%. Finally, Chesapeake's natural gas liquids production will jump by 43%.

Based on these numbers, the company's total production is expected to rise by roughly 3%, year over year. Even though this growth rate is modest, it might be revised upward in the coming months, as it was last year. For example, the company's current estimate for its 2013 daily natural gas equivalent production is set at 3,985 mmcfe -- over 2% higher than its initial estimate at the beginning of 2013. Moreover, the company sold several assets during last year. After controlling for the reduced assets, Chesapeake's production will increase by 8% to 10% during the year.

Nonetheless, the rise in oil production is lower than it was back in 2013, which is likely to slightly affect the company's valuation. But the market's reaction may have been a bit too severe, especially after considering that the company expects a 10% drop in production costs in 2014. The decline in production costs could improve Chesapeake's profit margin and thus increase its earnings. 

Another issue that may have contributed to the recent drop in the company's stock were the changes in its capital expenditure in 2014.   

Capital expenditure
Chesapeake plans to reduce its capital expenditure by 20% to an average of $5.4 billion. Keep in mind, however, that since the company sold several assets, its capex is likely to drop due to lower maintenance costs. Chesapeake didn't break down its capex between spending allocated toward maintaining its current assets and spending allotted to increasing its production.

For investors, capital expenditure translates to how much the company invests in its future growth. If the capex drops, this could suggest lower growth in production in the future. But since Chesapeake has fewer assets, this also means its capex allocated toward maintaining its existing assets will diminish in 2014, which could account for some of the reduced spending.

In any case, investors should consider Chesapeake's drop in capex with respect to other oil and gas producers, such as ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX). Chevron's capex sharply increased by 22% during 2013 to $41.8 billion. Looking forward, the company expects to keep increasing its capex, with a focus on its LNG projects in Australia, for which 2014 is expected to be the peak year for spending.

ExxonMobil also increased its capex by 6.8% in 2013, year over year. But the company's capex fell by 20% during the fourth quarter. This shift puts into question the rise in Exxon's capex in 2014. Both companies allocated roughly 10% of their respective annual capex to acquisitions. Therefore, Chesapeake's transition toward higher oil production, reduction in capex, and the changes in its assets should be taken into context when comparing to other petroleum producers.  

Bottom line
Chesapeake's situation isn't so dire. The company expects to further increase its production in 2014. The drop in capex is partly due to reduced assets and doesn't reflect a substantial cut in Chesapeake's investment in its future growth.  

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