Energy stocks have retreated quite a bit since the commodity bubble popped in mid-summer. The energy sector as a whole is down about 40% during this time frame while the S&P 500 is down a relatively moderate—in comparison—23%. Chesapeake Energy (CHK) has been particularly hammered in recent months, down a whopping 62% from its peak. Chesapeake is the nation’s largest natural gas producer and its stock has suffered from plunging gas prices as well as a debt load that is worrisome in this credit environment. There was also the embarrassing news story of the company’s CEO receiving a margin call as a result of the stock’s decline. Well, Chesapeake reported earnings yesterday and while the earnings were nothing spectacular they do give additional insights into the health of the company.
Chesapeake reported earnings of $.85 per share, excluding one-time events, which missed consensus estimates by 3.4%. Chesapeake had beaten estimates for the previous 3 quarters. However, the company had hedged pretty effectively against the falling price of natural gas and oil during the quarter which amounted to a gain of $2.8 billion and when you incorporate those profits into the results the company earned $5.61 per share. Clearly, there is a reason that analysts do not account for “one-time” events but it is certainly worth noting when there is such a huge difference. CHK hedged by securing higher prices in the past for delivery in the future, which could have come back to bite them had prices risen. Also in response to the lower price of natural gas Chesapeake has chosen to slow its production. During the past quarter, production fell .3% from the prior quarter and 15% from one year ago. This is a logical response to low prices and with demand for gas likely on the rise with high profile energy independence plans such as the “Pickens Plan” getting a lot of attention, odds are the price of natural gas will rebound.
Chesapeake stock has had an especially painful run of late because the company does have a substantial debt burden. The total liabilities have declined in the most recent quarter and total assets have increased. The ratio of total debt over total assets has fallen from 73% in the previous quarter to 59% in the quarter just ended. While 59% is still a large debt burden in such environment, the company is clearing enough cash right now to easily service this debt. Furthermore, the company has no senior notes maturing before 2013. In Chesapeake’s business, debt is inescapable as drilling requires substantial initial costs, and interestingly, the company’s asset-to-equity ratio of 2.44 is actually below its historical average of 3.1. It seems to me that CHK is generating enough cash to continue to reduce its debt exposure and, were the credit situation in the macro-economy to improve, CHK’s debt burden would seem pretty benign.
The assets Chesapeake owns undoubtedly have substantial value, and some particularly important assets are portions of the Marcellus Shale a huge natural gas field in the Appalachian Basin. Preliminary estimates are that this field holds up to 1.9 trillion cubic feet of gas (according to a 2002 U.S. Geological Survey), although these reserves are spread out over a massive area. Chesapeake, in its Oct. 19th conference call, estimated that its interests in the Marcellus Shale to be worth about $13.5 billion. That’s not too bad for a company with a market capitalization of about $12.5 billion. No wonder Chesapeake has considered selling some of these assets to the likes of BP (BP).
The fact of the matter is that Chesapeake calmed investors in with its recent quarter’s results. Yes the company has debt, but it is shrinking and not due for some time. Management effectively handled the eroding price of gas by hedging a significant portion of its production at higher prices. CHK has assets that, according to their own estimates, are worth more than the entire companies stock, so book value per share in theory exceeds the share price. Both price-to-cash flow and price-to-sales are significantly below their 10 year historical averages. So, although there are a lot of value plays in this market for patient investors, Chesapeake could be one of the best.