On one hand, last year was another tough one for investors in Chesapeake Energy (NYSE:CHK) after its stock plunged nearly 50%. However, amid all that carnage, Chesapeake made notable progress on its turnaround plan, which the company's CEO Doug Lawler outlined on its fourth-quarter conference call. He pointed out four reasons the oil and gas company believes it's heading in the right direction.
1. We made excellent progress on our strategic plan in 2018
Lawler started the call off by saying, "Chesapeake has delivered another strong year of operational and financial performance." He said it was "a year defined by improvements in every aspect of our business." Because of that, he believes "the investment thesis for Chesapeake Energy continues to grow as we advance our strategies of reducing leverage, achieving sustainable positive free cash flow, and enhancing our margins." The two most notable achievements last year were the sales of its Utica Shale assets and the acquisition of WildHorse Resources Development. Both deals enhanced its balance sheet metrics, while WildHorse also provided the company with a second oil growth engine.
2. We have a top-notch portfolio that has us well positioned to create shareholder value
Chesapeake has significantly reshaped its portfolio under Lawler's leadership over the last few years, which has helped narrow its focus on its best assets, while also adding WildHorse to the mix. As a result, Chesapeake now has a "robust, diverse portfolio," according to Lawler. He outlined key attributes by pointing out that the company now has:
Three powerful oil assets, with significant inventory and premium pricing. Two of these, the PRB and the WildHorse assets, will drive 2019 absolute oil growth of 32%, or 50%, when adjusted for asset sales. Two world-class gas assets, with more than 27 net trillion cubic feet of gas resources, geographically positioned to supply global LNG growth for decades to come. Significant exploitation and exploration acreage for further value creation and/or monetization.
Chesapeake has narrowed its focus to five core assets, three rich in oil and two containing abundant natural gas resources. On top of that, it has a significant amount of undeveloped acreage left to explore, which could bolster its growth prospects or balance sheet depending on what it decides to do with this land.
3. Our balance sheet is getting stronger
As noted earlier, one of the highlights last year was the significant improvement in Chesapeake's balance sheet. Lawler noted that "through the Utica divestiture, we reduced our net debt by $1.8 billion, and I'm pleased that, in total, we've eliminated $2.6 billion of secured debt last year." CFO Nick Dell'Osso drilled down a bit deeper into the company's balance-sheet improvement efforts by pointing out that:
We used proceeds from the Utica sale to repurchase debt, ending the year with $8.2 billion of debt outstanding, down from nearly at $10 billion at the end of 2017. Additionally, we refinanced our 2016 term loan with unsecured debt. The combined balance sheet improvements reduced our interest expense by approximately $150 million annually.
Those improvements led Moody's to upgrade Chesapeake Energy's credit rating in late October while putting it on review for a further upgrade following the close of the WildHorse deal. If it does win that second upgrade, which is still under review, the company's credit would be just one notch below investment grade, which is quite an improvement from where it was not more than a year ago. The ultimate goal would be to get its credit out of junk territory, which would not only improve its access to credit but also lower its borrowing costs.
4. We're narrowing the gap between cash flow and capex
As has been the case for several years, Chesapeake Energy outspent cash flow again last year as it only generated $1.8 billion in operating cash but spent roughly $2.4 billion on capital projects. However, that gap should narrow considerably this year. Not only is the company aiming to keep capex flat with 2018's level, but CEO Doug Lawler noted that at current oil and gas prices, "we expect our cash flow to be meaningfully stronger in 2019." Driving that view is the anticipated 32% uptick in higher-margin oil production as well as the continued decline in costs due to its interest expense savings and its ability to further reduce operating costs.
Chesapeake currently expects that there will be a "slight outspend in 2019." Though Lawler stated that:
We have a number of opportunities that we'll be evaluating to close that gap this year. I fully anticipate that we will, through continued efficiency in our operations, better capital performance, smaller asset sales, that we will close that gap in 2019 and organically be in position through our EBITDA generation to be in a sustainable situation if that's closed in 2020 going forward.
It's crucial that Chesapeake close this gap because it would improve the long-term sustainability of the company.
One step at a time
Chesapeake Energy is heading in the right direction. Its balance sheet has improved over the past year, and it has narrowed the gap between capex and cash flow. However, it's not there yet, which means it's well behind rivals that not only already have strong investment-grade balance sheets but are producing such a gusher of free cash that they're sending boatloads back to shareholders.