Chesapeake Energy Corporation Wellhead At Sunset

Source: Chesapeake Energy Corporation.  

Chesapeake Energy Corporation (NYSE:CHK) is the second largest natural gas producer in the country. Only ExxonMobil Corporation (NYSE:XOM) pumps out more natural gas. Not only that, but it's the fourth largest pure-play onshore oil producer in North America. Needless to say, it's a top energy company.

Further, Chesapeake Energy is in the middle of a major turnaround to grow its higher-margin oil production in order to fuel higher profits and cash flow. This is yielding double-digit production growth while at the same time drastically reducing the company's leverage.

The combination of Chesapeake Energy's production strength with its current turnaround efforts make it a compelling stock for investors. Those without a position might be wondering if this is a good time to buy the stock. Let's take a take a closer look.

Why Chesapeake Energy thinks it's time to buy its stock

As part of its turnaround plan Chesapeake Energy is focused on growth that creates value. This strategy is laid out on the following slide, where the company points out that it plans to lead the industry in capital efficiency while reducing its leverage and complexity to grow its core areas and its cash flow.

Chesapeake Energy Corporation Strategy

Source: Chesapeake Energy Corporation Investor Presentation.  

This is a strategy borne out in the company's numbers. In this next slide, we look at a company that has dramatically cut its capital expenses as it focuses on being more efficient with its capital.

Chesapeake Energy Corporation Capex

Source: Chesapeake Energy Corporation Investor Presentation. 

What's pretty remarkable is that even with the major cuts in capital spending, Chesapeake Energy is still able to grow. In this following slide, the company points out that its cash flow matches its capex, and yet the company is still growing production by 9%-12% while also slashing its leverage by 20%.

Chesapeake Energy Corporation Delivering

Source: Chesapeake Energy Corporation Investor Presentation. 

Add it all up and we have a compelling turnaround. The only question that remains is if we can invest in this turnaround at a decent price. For that, we need to drill down a bit deeper into the company's valuation.

Drilling down into the numbers

In an effort to put a realistic value on Chesapeake Energy I'm going to look at a basket of four common energy valuation multiples for the company and four of its closest peers. The peers I'm using -- Devon Energy (NYSE:DVN), ConocoPhillips (NYSE:COP), EOG Resources (NYSE:EOG), and Pioneer Natural Resources (NYSE:PXD) -- are among the top tier of independent oil and gas companies in North America.

Here's how Chesapeake Energy compares:

Company

Price/Earnings

Enterprise Value/EBITDA

Enterprise Value/Total Revenue

Price/Tangible Book Value

ConocoPhillips

11.6x

4.9x

1.9x

1.8x

Chesapeake Energy

27.1x

6.3x

1.9x

1.4x

Devon Energy

18.6x

6.8x

3.4x

2.2x

EOG Resources

28.4x

7.9x

4.0x

3.5x

Pioneer Natural Resources

42.5x

16.4x

8.6x

3.5x

Source: S&P Capital IQ.

What we see here is that on a relative basis Chesapeake Energy is a lot cheaper than its price to earnings multiple would lead us to believe. This is why I personally never use that valuation multiple when looking at an oil and gas stock because it can be affected by items such as hedging gains or losses as well as asset write-downs that obscure the whole story. By drilling down a little deeper into a couple of other valuation multiples, we see that Chesapeake Energy is cheaper than Devon Energy when it comes to its enterprise value to EBITDA, while it's the cheapest of the bunch when comparing the price to tangible book value. This tells us that, relative to its peers, Chesapeake Energy might be a good stock to buy.

Now I'm going to compare Chesapeake Energy's current valuation to its historical valuation by going back a decade and seeing how the company's current valuation multiples stack up to its historical average.

Chesapeake Energy

2014

Historical Average (Last 10 Years)

Price/Earnings

27.1x

16.0x

Enterprise Value/EBITDA

6.3x

7.3x

Enterprise Value/Total Revenue

1.9x

3.2x

Price/Tangible Book

1.4x

1.3x

Source: S&P Capital IQ.

Here we see that aside from its price to earnings ratio Chesapeake Energy is trading below many of its historical average valuation multiples over the past 10 years. In fact, the company's enterprise value to EBITDA ratio is particularly compelling, as the current ratio is at a nice discount to the company's historical average as well as to the current multiple of most of its closest peers.

Investor takeaway

From this, we can conclude that today is actually a pretty good time to buy Chesapeake Energy's stock. The company is making solid progress on its turnaround plan, and its stock is selling at a compelling valuation both compared to its closest peers as well as to its historical valuation.

Matt DiLallo owns shares of ConocoPhillips. The Motley Fool owns shares of Devon Energy and EOG Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.