Is Chesapeake Energy's $1 Billion Stock Buyback a Bright Idea?

With the stock market at near-record highs, but the Federal Reserve set to hike interest rates, many investors are growing nervous about stocks. Many, but not all.

Corporations, for example, continue to plow billions (and more billions) of dollars into buying back their own stock. Just last month, Chesapeake Energy (CHKA.Q) announced plans to repurchase $1 billion worth of its shares. Is this a savvy financial move to scoop up cheap shares, or a misguided attempt by management to revive a sinking stock?

Today, we'll find out, as we ask two basic questions:

Can it pay?
Surprisingly -- yes! At last report, Chesapeake Energy had a mere $90 million worth of cash and equivalents on its books. But in December, the company sold off its southern Marcellus shale assets and a portion of its eastern Utica shale to Southwestern Energy (SWN 0.14%), generating $4.975 billion in net proceeds. Thus, even if Chesapeake Energy is not generating positive free cash flow (indeed, according to S&P Capital IQ, Chessie has not generated full-year cash profits even once since 2006), it has money in the bank -- and the ability to fully fund its buyback program.

Should it pay?
That, I'm less sure of. Granted, the company now has enough money for the buyback. But Chesapeake Energy is also carrying $11.7 billion in debt. Shouldn't Chesapeake perhaps think about applying some of its $5 billion in available cash to paying down its debt?

The answer is that it depends on how you look at the numbers, and which numbers you look at.

All peer comparisons  courtesy of finviz.com.

Compare Chesapeake Energy stock to its peers in the oil and gas space on traditional stock-valuation metrics, and you'll see that in just about every category, those comparisons are unfavorable.

Chesapeake boasts the highest price-to-earnings ratio in this group. It has the lowest dividend payout (discounting Southwestern Energy, which pays no dividend), and the slowest (actually negative) projected profit growth rate to boot. If evaluated according to a stock's "total return" ratio, ExxonMobil is expensive and Southwestern Energy doesn't offer much return for its price, but Chesapeake seems to offer no likely return for investors at all.

Value is in the eye of the beholder
Are there other ways to look at the stock, and at the numbers? Yes. For example, you could argue that since Chesapeake just sold off assets responsible for 7% of its daily production of oil and gas, and got nearly $5 billion for them, then logically the assets that remain within Chesapeake should be worth 14 times that divestiture price -- $70 billion, or perhaps $63 billion net of cash and debt.

Or, if you want to dig deep into Chesapeake's SEC filings, you might notice the company disclosed last fall that the "net proved reserves associated with the [assets sold to Southwestern] were 221 million barrels of oil equivalent," or BOE. Total proven oil reserves at Chesapeake at the end of last year were equal to 423.8 million barrels. Add total proven reserves of natural gas liquids (299 million barrels) and of natural gas (11,734 billion cubic feet, or 2.1 billion barrels of oil equivalent), andthat works out to 2.8 billion BOE in total proved hydrocarbon reserves.

So again, that's nearly 13 times the assets that Chesapeake just sold for $5 billion, suggesting a total worth for the company of $64 billion (minus debt and plus cash, $57 billion).

What it means to investors
Given that all of Chesapeake Energy stock sports a market capitalization of just $12.4 billion, either of these latter two methods of valuing the company on its assets suggest it is deeply undervalued -- and management is right to be buying back shares. Meanwhile, valuing the company on its profits suggests the opposite.

In the end, whether you agree with management's decision to buy back shares depends on how you look at Chesapeake itself. Viewed as an asset play, the stock is cheap. Viewed as a business that is supposed to earn profits and pay out generous dividends, it isn't.