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Is Chesapeake Energy a Buy?

Matthew DiLallo, The Motley Fool

Chesapeake Energy's (NYSE: CHK) stock has been excruciatingly volatile over the past year. Shares of the oil and gas driller were up 35% at one point last year, but tumbled along with oil prices during the final quarter, ending 2018 down 47%. Those wild swings have continued in 2019. Shares rocketed out of the gate and were up more than 50% at one point. The stock has since come back down to earth and is currently down about 2% for the year because oil has fallen back a bit from its high.

Clearly, in the right market, Chesapeake Energy has significant upside potential. However, the stock also has several issues that can weigh it down when conditions shift. Because of that, investors need to carefully consider several factors before buying Chesapeake Energy's stock.

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The bull case for Chesapeake Energy

Chesapeake Energy has worked hard over the past few years to improve its financial profile so that it can prosper in any oil market. The company sold a string of assets in recent years to help pay off some of its mountain of debt, which is starting to give it the financial flexibility to invest in high-return opportunities. The oil and gas driller used its improving profile to acquire fast-growing oil driller WildHorse Resource Development earlier this year. That transaction will not only accelerate the company's oil production growth rate but its ability to achieve its balance sheet targets.

The deal has already started paying dividends, which was evident in Chesapeake Energy's strong first-quarter results. As a result, the company is on track to achieve its goals to generate enough cash from its operations to support its growth plan while also reducing its leverage ratio. As this turnaround plan continues to deliver results, it could act like lighter fluid and ignite Chesapeake Energy's stock price.

The bear case for Chesapeake Energy

While Chesapeake Energy has come a long way in recent years, it still has much work to do. For starters, the company isn't living within its means since it's outspending cash flow to fund growth. While Chesapeake believes it will hit an inflection point in the next year, it needs a much higher oil price than most peers to provide it with enough cash to support its growth plan.

Meanwhile, Chesapeake Energy still has a much weaker balance sheet compared to most peers. The company wants to reduce its leverage ratio so that debt is less than 2.0 times its EBITDA. However, even with the benefits of the WildHorse acquisition, leverage will only fall to about 3.6 times this year and is on track to be around 2.8 times in 2020. That would still be well above the 1.0-1.5 times target of most peers. Chesapeake's elevated debt level not only puts it at a disadvantage compared to rivals but will likely continue to weigh on its stock, especially when oil prices fall.

Verdict: Chesapeake Energy is still too risky to buy

While Chesapeake Energy has intriguing upside potential as it continues to improve its balance sheet and grow its oil production, the company still has two major issues. Not only is it outspending cash flow, but it remains mired in debt. Consequently, the stock is too risky to buy since it could take another tumble if oil prices slump again.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.