Chesapeake Energy Corporation’s CHK shares have had quite a volatile run, surging more than 32% in the first six months of 2018 but plunging 47% by the end of the year. The upstream explorer again rebounded sharply in 2019, with its share price rallying 63.8% year to date, handily outperforming the industry’s growth of 13.7%.
With the stock still trading 40% below its 52-week highs, the question is does the rally have legs?
What Dragged the Stock Down in 2018?
Indeed, the year 2018 had been a tumultuous one for Chesapeake owing to oil price crash in the final months of the year and other factors. After touching multi-year highs of more than $76 in early October 2018, crude plunged in excess of 40% since then on fears of supply glut and economic headwinds.
Investors’ confidence was further dampened by the ill-timed high-cost buyout of WildHorse Resource Corporation in October 2018. The $4-billion deal in cash and stock diluted the ownership of the company’s shareholders. The deal represented a significant departure from the company’s efforts to vend its non-core assets for reducing debt. Further, amid weakening oil prices during that time, Chesapeake’s bold bet did not seem too prudent.
As it is, the company’s stretched balance sheet has been a huge headwind. The debt load of the firm was around $10 billion at the beginning of 2018. While the company inked several small deals in efforts to trim leverage, it made a big divestment decision to sell its entire acreage in the Utica shale play for $2 billion in third-quarter 2018. However, the sale did not prove much of a needle-mover transaction as market experts believed that the assets were sold at a discount.
What’s Fueling the Stock in 2019?
With oil prices gathering steam, shares of Chesapeake have bounced back ably so far this year. Markedly, the March quarter of 2019 recorded the fastest rate of oil price increase since 2009, with crude rising 30%, underpinned mainly by OPEC+ supply cuts, and U.S. sanctions against Venezuela and Iran. With the commodity prices bottoming out in late December, WTI crude is currently trading at around $64 a barrel, proving to be a boon for the company as its share price rose around 64% on a year-to-date basis.
Amid strong pricing environment, investors are becoming optimistic about Chesapeake’s acquisition of oil-focused WildHorse, which bolstered the firm’s position in the prolific oil-rich Eagle Ford acreages.The addition of profitable Eagle Ford acres is likely to boost the company’s higher-margin oil output, cash flows and earnings. While the company has reduced its rig count by 20% this year, it has projected its oil output to grow 32%, thanks to the WildHorse buyout.
Better-than-expected results in the fourth quarter also added to the company’s gains. During the fourth-quarter conference call, the company projected the proportion of oil in total production to increase from 18% in fourth-quarter 2018 to 26% by 2019-end. Amid healthy oil prices, this encouraging projection is expected to reduce commodity price risk, and stabilize the company’s earnings and cash flows.
The stock also got impetus from the news that Chesapeake’s CFO Domenic boosted his stake holdings in the company. The share purchase by management reflected Chesapeake’s robust business potentials. The company anticipates adjusted EBITDA/barrel of oil equivalent in 2019 to be $14.50, significantly higher than $12.81 in 2018 and $10.83 in 2017.
Notably, Chesapeake faced cash flow crunch last year amid weak oil prices, generating $2 billion while spending around $2.4 billion. Although the company anticipates outspending this year as well, the figure is likely to be much lower than the prior year. In fact, if the oil prices keep up its momentum, the company will be able to become cash flow neutral. Further, the CEO is evaluating various opportunities to improve cash flows and financials of the company via efficiency gains, divestment programs and higher output.
We do believe that the company should keep up with asset monetization initiatives to chip away the massive debt, which still stands at around $8 billion. If crude prices continue to remain red hot, the WildHorse deal is likely to emerge as the major growth engine for the company. The firm expects output from Powder River Basin acreage to more than double this year.
Rebounded oil prices, increased optimism about the WildHorse buyout and Powder Basin region, better-than expected results in the fourth quarter, higher output guidance for 2019 and boosting stock holdings in the firm by management helped Chesapeake erase the losses of 2018.
While the company believes that the WildHorse deal will definitely pay off in the long term, things might backfire if oil prices tumble again. Although management is undertaking various initiatives to reduce the elevated leverage, it is still behind its target levels. Hence, we advise investors to remain in sidelines for the time being before accumulating more shares of this Zacks Rank #3 (Hold) company. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Instead, investors interested in the energy space can consider buying these better-ranked stocks like Shell RDS.A, Braskem S.A. BAK and YPF Sociedad Anonima YPF, each carrying a Zacks Rank #2 (Buy).
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