Like a moth drawn to a flame, I just can't help taking a look at controversial stocks, rather than dismissing them immediately. I may leave unsatisfied nine times out of 10, but every now and then, I find a true bargain.
When both optimists and pessimists fight over a stock, value investors must proceed with caution. Sometimes, an apparent bargain has very good reasons for its cheap valuation. With that in mind, let's take a look at the hotly debated Chesapeake Energy (NYSE: CHK).
Exploring the positives
Investors are drawn to Chesapeake for its vast resources: 2.5 million net acres in natural gas shale plays and 5.1 million net acres in unconventional liquids plays, including the Anadarko Basin, Eagle Ford shale, and Permian Basin. Relative to its size, its amassed acreage position is quite impressive.
Let's compare its operating cash flow to that of its peers:
|
Company |
Trailing Cash Flow From Operations* |
Market Cap on July 8, 2011* |
Market Cap / CFFO |
|---|---|---|---|
| Brigham Exploration (Nasdaq: BEXP) |
$185 |
$3,650 |
19.76 |
| Chesapeake Energy |
$4,675 |
$19,406 |
4.15 |
| Devon Energy (NYSE: DVN) |
$5,243 |
$33,975 |
6.48 |
| Encana Corporation (NYSE: ECA) |
$3,771 |
$21,588 |
5.72 |
| EOG Resources (NYSE: EOG) |
$3,046 |
$27,359 |
8.98 |
| Noble Energy (NYSE: NBL) |
$1,842 |
$16,134 |
8.76 |
| QEP Resources (NYSE: QEP) |
$1,097 |
$7,413 |
6.76 |
Source: Capital IQ, a division of Standard & Poor's.
* In millions.
As you can see, we have a company with an impressive collection of assets, trading at a lower multiple of its cash flow than any of its peers. What could go wrong?
Plenty, it turns out.
Hard to believe
CEO Aubrey McClendon's compensation represents a huge part of the stock's bear argument. McClendon made $21 million in total compensation in 2010. Even worse, his total compensation package in 2008 reached $112 million. There's no defending that absurd number, and I can't blame the many people turned off by McClendon's massive paydays.
Furthermore, I wonder whether Chesapeake's vast collection of assets is actually too much. Chesapeake doesn't have the resources to drill all of its acreage. Why acquire land that it can't even develop on its own? Those rights aren't cheap, as many oil and gas companies know all too well.
We're not crying wolf
The company itself clearly thinks its stock's undervalued. To regain investor confidence, Chesapeake has launched a two-part plan for the next two years: Sell assets to reduce long-term debt by 25%, and increase production by 25%.
Chesapeake has already started the first part of that strategy, most notably by selling its Fayetteville Shale gas assets earlier this year for $4.65 billion. Moreover, the company says it plans additional sales before 2011 is up.
Given its history of racking up debt and continually buying more acreage than it can develop, many investors remain skeptical of Chesapeake's prospects. This could make the company a value trap -- or a potential home run.
Foolish bottom line
Chesapeake is one of the most polarizing stocks I've seen. I side with the bulls on this one, because I'm a sucker for a company with a ton of hard assets, but I acknowledge that the bears have very good arguments. As such, I will be watching this company closely to see if it continues its plan to reduce debt and increase production. It would signal the end of the era of irresponsibility and bring about a higher share price.
Interested in the companies mentioned? Add them to your Foolish watchlist.
