Chesapeake Energy (CHK +0.00%) is one of the most popular stocks in the energy sector even though its share price has cratered over the past year. As its price has fallen, however, speculators have been snapping up shares, fueled by the view that what has gone down must go back up. The stock's surging popularity probably has those on the outside looking in wondering if they should jump on the bandwagon.
Here's a look at what's fueling the bullishness as well as what could go wrong.
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Why speculators are scooping up Chesapeake's stock
Shares of Chesapeake Energy have cratered 97% over the past year. Two factors are driving this sell-off. First, oil and gas prices have tumbled because of a massive oversupply, which has eaten into Chesapeake's cash flow and weighed on the value of its assets. That's making it nearly impossible for the company to manage its debt.
Chesapeake bulls, however, believe that the company can make it through this rough patch if oil and gas prices rebound. While the company has nearly $9 billion of debt outstanding, only $300 million of that matures this year. Thus, if prices rebound sharply, Chesapeake could be able to address this near-term maturity by selling assets as values recover. That catalyst has the potential to fuel a big rally in the stock price, allowing speculators to make a quick profit.
Why investors should steer clear of Chesapeake's stock
Those betting that Chesapeake can survive are playing a dangerous game. That's because multiple news outlets have reported that Chesapeake Energy is precariously close to filing for bankruptcy protection. In late April, for example, Reuters reported that Chesapeake was preparing to declare bankruptcy and had discussions with creditors on a $1 billion financing package that would help it navigate through the proceedings.
Meanwhile, in early May, credit rating agency S&P Global said that a bankruptcy filing from Chesapeake was a "virtual certainty" in the next few months. While the company has six months of liquidity, it will undoubtedly file before the summer. That's because it has $135 million of interest payments due in June and a $208 million debt maturity in August. A bankruptcy filing could render Chesapeake's stock worthless, since it would probably need to exchange all its remaining equity for debt relief from its creditors.
That's an outcome one of its largest investors would like to avoid. Franklin Resources, which holds 12.4% of Chesapeake's stock as well as some of its debt, has hired advisors to help lead restructuring talks with the beleaguered oil and gas company. These discussions could enable the company to work out a pre-negotiated bankruptcy package that might preserve some shareholder value. One of Chesapeake's peers, for example, filed for bankruptcy protection with a pre-negotiated deal that would wipe away $2.2 billion of its $2.8 billion in debt in exchange for 97% of the company's equity, meaning existing shareholders would get to keep 3% of the company. Thus, a similarly structured settlement by Chesapeake could conceivably enable investors to retain some value.
However, even if that happens, it doesn't mean Chesapeake's stock will rise in value, since it would significantly dilute existing investors. They've already seen their share of the company cut by more than half since the start of last year because it issued stock to buy oil driller WildHorse Resource Development and complete several debt exchanges. The flood of new shares needed to extinguish a meaningful portion of its remaining debt would probably weigh on the stock like an anchor, hindering it from rebounding even if oil and gas prices bounced back.
Chesapeake Energy's stock is a risky gamble
This year's oil price crash will probably be the final nail in the coffin for Chesapeake Energy. While there's a remote chance the stock will retain some value following a bankruptcy filing, the upside probably won't amount to much, given the amount of dilution and significant supply overhang in the oil and gas market. That's why investors should steer clear of this energy stock.
