Investing in turnaround stocks can be lucrative if you follow one rule: Focus only on companies that have identified the root cause of their problems and have crafted a clear plan to repair their business.
For struggling natural gas company Chesapeake Energy (CHK +0.00%), the path to profitability has already been laid out to shareholders. This has given investors a short time window to buy million of acres of high-quality natural gas assets on the cheap.
Getting its house in order
Chesapeake has come a long way since its days under former CEO Aubrey McClendon. Under his leadership, the company launched an aggressive growth campaign buying up vast tracks of land, financed in large part by complex partnerships and junk bonds. But when the bottom fell out of natural gas prices, Chesapeake found itself saddled with an over-leveraged balance sheet, and more land than it could profitability drill.
Enter new CEO Doug Lawler, who became tasked with turning around the organization. During his first conference call, the former Anadarko Petroleum executive outlined his strategy:
- Use additional asset sales to close the company's funding gap and pare down debt
- Shift production mix to more profitable natural gas liquids
- Improve corporate governance
- Renew cost-cutting efforts
Lots of catalysts
But, Chesapeake has several catalysts that could drive its share price over the next year or two.
First, the company is making a shift to a more profitable liquids production mix. In 2009, only 10% of Chesapeake's production was liquid. But, by the end of last year, that percentage rose to 25%. And that figure could rise further as the company continues to invest in liquids and oil-rich assets like Eagle Ford and the Mississippi Lime.
Second, expect to see operational costs fall sharply in the coming quarters due to the company's transition to pad drilling, the falling cost of hydraulic fracturing services, and other efficiencies.
Third, the company is once again the subject of takeover speculation. Earlier this month, The Daily Mail passed along a rumor that Chesapeake could be in the sights of a British oil major like BP (BP 4.02%) or Royal Dutch Shell. I doubt Shell would be interested after the company announced its exit from the U.S. shale boom. But such an acquisition would allow BP to inexpensively acquire high-quality acreage that would nicely compliment the company's existing asset base.
Foolish bottom line
Chesapeake reports earnings on November 6. This will be Lawler's first conference call after laying out his turnaround strategy this past summer. Investors should be watching the company's metrics (i.e. production mix and leverage ratios) to ensure management is executing its plans.
No doubt Chesapeake is a troubled company. But new CEO Doug Lawler has put a comprehensive plan in place to right the firm's financial ship. So there are plenty of catalysts that could send shares higher over the next year.
