Is Chesapeake Energy Corporation Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Chesapeake Energy (CHKA.Q) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Chesapeake Energy's story, and we'll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Chesapeake Energy's key statistics:

CHK Total Return Price data. Source: YCharts.

Source: YCharts. * Period begins at end of Q1 2011.

CHK Return on Equity (TTM) data. Source: YCharts.

Source: YCharts. * Period begins at end of Q1 2011.

How we got here and where we're going
Chesapeake's score count fell down since we first looked at it last year, as the oil and gas producer only racked up five out of nine possible passing grades in its second assessment, down from a nearly perfect eight-of-nine score in 2013. The company has struggled with declining profit margins, but its real problem is the persistent weakness in its free cash flow, which was nearly $5.5 billion on a trailing-12-month basis last year after a string of asset sales -- some rather severe revisions have been made to its financial statements since then, as you can see. Improvement from bad to less bad on this metric earned Chesapeake one passing grade, but it can't sustain its dividend with this much cash flowing out every quarter. Can Chesapeake improve on its fundamental weaknesses to earn the rare perfect score that eluded it in 2013 when we return to examine it next year? Let's dig a little deeper to find out.

Chesapeake's shareholders should be pleased by the quick turnaround in oil and natural gas liquids (NGLs) production levels, which were hampered by inclement weather conditions in Mid-Continent and Eagle Ford shale regions during the first quarter. The company plans to further increase its NGL production to capitalize on rising natural gas prices, which could result in a surge on the bottom line over the coming months.

My fellow writer Lior Cohen notes that oil output in the Eagle Ford, which accounts for approximately 64% of Chesapeake's total production in the region, is likely to improve in both net production terms and as a percent of total regional petroleum production as the company directs its resources toward increasing the number of producing wells in the region. The company's net production in the Eagle Ford is already up 17% year over year -- from 75,000 barrels of oil equivalent (BOE) per day in 2012 to 88,000 BOE per day last year, and this figure is expected to grow further with higher capital expenditures in the shale play. However, the company's hedge mechanism might wash out any gains from future price spikes, since Chesapeake's realized price for natural gas could wind up much lower than the current (or future) market price.

In recent months, the company has enjoyed a marked decline in production costs as it divests less profitable properties to focus on its brightest opportunities. Chesapeake's also accumulating substantial cash resources through its divestment efforts, which will go toward decreasing net leverage by around $3 billion. Quite recently, the company revealed its plans to sell non-core assets in Southwestern Oklahoma, East Texas, and South Texas, which should help it further tighten the belt on production costs in the near future.

Chesapeake continues to focus its efforts on developing unconventional shale plays such as the Utica and Marcellus shales, to reach its goal of 1 million barrels of oil equivalent of daily production. The company will invest more than $5 billion on capital expenditures this year, as it plans to drill more than 260 wells in four lucrative properties over the next two years. On a longer timeline, Chesapeake could drill more than 10,000-plus wells, based on its current land inventories in North America. Lior notes that total Eagle Ford production (from all producers) could reach 2 million barrels per day by 2020, up from around 1.4 million barrels per day now.

Putting the pieces together
Today, Chesapeake has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.