Shares of Chesapeake Energy (NYSE:CHK) have been nauseatingly volatile over the past year. The oil and gas producer's stock was up 35% at one point in 2018 before plunging along with oil prices over the final few months, finishing the year down 47%. The company has bounced back sharply in 2019 -- rocketing more than 50% since the start of the year -- fueled by the best quarter for oil prices in a decade.
The company, however, might have more room to run since shares remain 40% off their high from last summer. Here's what could give them the fuel to continue rallying, even if crude prices level out.
Closing the gap
One of the reasons Chesapeake Energy tumbled last year is that it needs higher oil prices to support its operations. The plunge in crude prices late last year cut into the company's cash flow, causing it to once again live beyond its means as it hauled in $1.8 billion in cash but spent $2.4 billion on drilling more wells.
The company, however, entered 2019 anticipating that there would only be a slight outspend this year, thanks in part to its acquisition of the oil-focused Wildhorse Resource Development, which would help boost the company's higher-margin oil output by 32%.
CEO Doug Lawler also noted on the company's fourth-quarter conference call that Chesapeake was evaluating several opportunities to close that gap this year, including continued efficiency gains, better capital performance, and small asset sales. Those efforts have gotten a boost from higher oil prices, which will make it much easier to close the gap. If the company achieves its long-standing goal of cash flow neutrality, that could provide a boost to shares since it would put Chesapeake on a much more sustainable financial footing.
Making a bigger dent in debt reduction
Chesapeake Energy made excellent progress on its balance sheet improvement efforts last year due in part to the sale of its Utica Shale assets. That enabled the company to pay off $1.8 billion in debt, reducing the total to $8.2 billion, which helped cut its annual interest expenses by $150 million.
The company's leverage level, however, remains high, which is why it still has junk-rated credit. Chesapeake hopes to continue improving its financial profile by growing its higher-margin oil production, which it accelerated by acquiring WildHorse. In the company's view, leverage should decline to 3.6 times this year and fall to 2.8 times by 2020, which is closer to its 2.0 times target.
The uptick in oil prices this year will certainly help keep the company on track with that goal. However, it could nudge the needle further in a positive direction by continuing to sell assets.
While Chesapeake plans to target smaller sales this year, it could make a bigger dent in its debt pile by monetizing acreage in one of its more valuable core regions, such as in the Mid-Continent, which it's currently holding as an option for future growth. If the company can pay off a meaningful amount of debt this year, that would help lift a weight that has been holding down the stock. Further, it would also likely enhance the company's cash flow by reducing interest expenses, which would make it much easier for the company to balance capital spending with cash flow.
High reward, but with boatloads of risk
Chesapeake Energy has bounced back sharply this year thanks to a big-time rebound in crude prices. That rally could continue since the company has quite a few catalysts that could give shares the fuel to keep going higher, even if oil prices plateau.
However, while Chesapeake has lots of upside potential, there's a real risk that shares could plunge if oil prices cool off. That's why investors might want to watch this red-hot oil stock from the sidelines and consider one of these less risky options instead.