Despite sharper-than-expected quarterly results and management guidance for solid production growth, shares of Chesapeake Energy Corporation (CHK) declined approximately 24% year-to-date. While we believe the natural gas-centric negative sentiment played a vital role in this downturn, the company’s growing focus on liquids is commendable.
With over ten-year drilling inventory in core shale gas plays and a diverse onshore U.S. asset portfolio (13.9 million net acres), we believe Chesapeake’s upside potential is greater than its downside risk.
The company is striving to fund its capital expenditure by making joint ventures in shale plays. Its estimated proved reserves increased 8% from the year-end 2009 level. We appreciate the company’s initiatives to enhance its reserves base and lower the debt level, which ultimately land it in a favorable debt rating scenario.
Net income in the second quarter was 75 cents per share, well above the Zacks Consensus Estimate of 69 cents and the year-earlier profit of 62 cents.
Total revenue increased more than 20% to $2.01 billion, but was below the Zacks Consensus Estimate of $2.45 billion.
We have discussed the quarterly results at length here: Chesapeake Tops on Higher Volumes
Agreement of Analysts
We notice a mixed response in annual earnings estimate revisions. Over the last one month, 10 out of the 30 analysts raised their projections for 2010, while 12 moved in the opposite direction. One analyst lowered the estimate in the past seven days. For 2011, 11 out of the 29 analysts covering the stock moved upward in the last 30 days, while 7 reduced their expectations. However, we noticed no upward movement in the last 7 days though one has lowered the estimate.
Magnitude of Estimate Revisions
The Zacks Consensus Estimate for fiscal 2010 decreased 7 cents over the last month and for fiscal 2011 it decreased 11 cents. However, 2010 estimate remained flat with week-ago estimates and 2011 estimate was down 2 cents. The current Zacks Consensus Estimate is pegged at $2.97 and $2.85 for 2010 and 2011, respectively.
Neutral Rating Maintained
We appreciate Chesapeake’s initiative of deploying more funds toward liquids. In the current scenario of an uptrend in oil prices, the company is planning to deploy more capital to drill liquids-rich plays, particularly Granite Wash, Eagle Ford Shale, Anadarko Basin, Permian Basin and the Rocky Mountain unconventional plays. For 2011, Chesapeake plans to spend $400 million more for liquids-weighted plays by reducing gas-plays budget.
Given Chesapeake’s industry leading growth profile, competitive cost structure and management’s track record of outperformance, the company is better positioned compared with many of its peers. Though the increasing focus on liquids is appreciable, the ultimate benefit from it is a time consuming matter. Until then, our short-term (1-3 months) as well as long-term (6+ months) recommendation remains unchanged at Neutral with the Zacks #3 Rank (Hold).