Chesapeake Energy (NYSE: CHK ) , the Oklahoma City-based oil and gas producer, reported strong first-quarter financial results last week that handily beat analysts' expectations, fueled by production growth in oil and natural gas liquids, or NGLs, that was better than expected, along with sharply higher natural gas prices and lower per-unit production expenses.
Adjusted for one-time items, the company earned $0.59 per share, well ahead of the $0.48 analysts were expecting. Let's take a closer look at three key takeaways from the company's first-quarter performance that bode well for its future.
Better-than-expected production growth, improving capital efficiency
Some of the most impressive points from the company's quarterly report were a 34% year-over-year surge in adjusted EBITDA, which came in at $1.515 billion, and a 37% year-over-year jump in operating cash flow to $1.614 billion, fueled by better-than-expected production growth and sharply higher natural gas prices.
Adjusted for asset sales, the company's quarterly oil and gas production increased 11% year over year to 675,200 barrels of oil equivalent per day, with daily oil production rising 20% year over year, NGL production surging 63%, and natural gas production rising 4% compared with the year-earlier period. The company also received an average price of $3.27 per Mcf for its natural gas during the quarter, up 72% year over year.
Most impressively, Chesapeake was able to achieve this better-than-expected growth while spending a whole lot less money, which speaks to continued improvements in capital efficiency. First-quarter capital expenditures of $850 million fell by 37%, or $422 million, from the fourth quarter of 2013, largely as a result of fewer well completions and a marked reduction in average capital cost per well, which fell by several hundreds of thousands of dollars compared with 2013 levels.
Stronger production and cash flow outlook
Reflecting the company's expectations for higher natural gas liquids volumes over the remainder of the year largely because of the start-up of the ATEX pipeline, which provides substantial takeaway capacity from the liquids-rich Utica shale, management raised its 2014 total production growth outlook to a range of 9%-12%, up from its previous guidance of 8%-10%.
As a result of this improved production forecast and an increase in Chesapeake's commodity price outlook for the remainder of the year, management increased the midpoint of its 2014 operating cash flow outlook by $700 million, or 13%. Chesapeake is now forecasting full-year 2014 operating cash flow of $5.8 billion to $6 billion, up from $5.1 billion to $5.3 billion previously.
This is a highly encouraging development, because it means the company will finally be spending within its cash flow this year, assuming it can stick to its full-year 2014 capex guidance of $5.2 billion to $5.6 billion, which greatly reduces funding concerns and improves its risk profile.
Improved liquidity, falling leverage
Meanwhile, Chesapeake's continued success with its asset sale strategy, combined with stronger operating cash flow and lower-than-expected drilling and completion costs, is helping reduce its leverage and improve its liquidity. Year to date, the company has generated proceeds of more than $925 million from asset sales, on top of roughly $11 billion in monetization proceeds in 2012 and 2013.
Chesapeake ended the quarter with a little over $1 billion in cash and equivalents, up from $837 million as of year-end 2013, and has additional liquidity in the form of a syndicated revolving bank credit facility maturing in December 2015 with a borrowing capacity of $4 billion. It is also pursuing strategic alternatives for its oilfield services division, which could bring in proceeds in excess of $1 billion if an outright sale were to be pursued.
While the company's level of long-term debt remains uncomfortably high at $12.65 billion as of the end of the first quarter, down only slightly from $12.89 billion as of the end of 2013, Chesapeake's improved outlook for production, earnings, and cash flow, coupled with a dramatic reduction in capital spending, means leverage should continue to improve gradually.
Overall, Chesapeake turned in a truly impressive quarterly performance, highlighting the success of its new strategy of targeting stronger liquids production growth, continued cost reductions, and greater capital efficiency. With shares currently trading at around 12.5 times forward earnings, however, Chesapeake no longer appears significantly undervalued, in my view, considering its relatively high degree of leverage to natural gas. Still, I think the stock presents a compelling long-term opportunity.
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