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Chesapeake Energy Corporation Could Be Setting up for a Big Breakout

Bret Kenwell

Chesapeake Energy Corporation (NYSE:CHK) has been under pressure all year, down more than 40% in 2017. However its stock is starting to shape despite questionable fundamental developments. Let’s see what CHK stock price is doing and then dig into some of those numbers.

Trading CHK Stock Price

chart of CHK stock price

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There’s a lot going on in Chesapeake’s stock chart. There is support near $3.50, but a hearty downtrend line near $4. So in a way, CHK stock is in make-or-break territory.

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It’s coiling just under the current downtrend line, which is good. The green line is acting as a short-term “higher highs” support line.

If CHK stock price can breakout over $4, it could breathe new life into the name. The only issue that looms beyond $4? $4.50. Let’s not get over our skis and say that CHK will be over this level by year’s end.

However, a break over $4 could easily send CHK stock to $4.50. It may seem small, but don’t discount a 12.5% rally.

Fundamentals

While CHK stock price is setting up bullishly, let’s take it all with a grain of salt. The company currently sports a $3.8 billion market cap but carries nearly $10 billion in debt. Total cash on hand stands at $5 million.

While a big boost of cash in the December quarter that bleeds down throughout the year this is typical of CHK, it is a bit unsettling. While the $5 million is up from $4 million in the same period last year, debt is up too, climbing $221 million year-over-year (YoY).



In the latest quarter, management said it expects to have flat to modest production growth in 2018. That in itself is not very positive, although doing so on lower capital expenditure is appealing.

At the same time, spending to grow higher return-on-investment (ROI) assets is the name of the energy game. So there’s a double-edged sword here.

Lower spending ensures lower growth, which is bad. But lower spending and flat growth equals better margins. With trailing free-cash flow (FCF) sitting at negative $424 million, CHK needs to find a way to turn this figure into $0 and then make it positive.

Without FCF, Chesapeake can’t pay down debt and will have trouble growing. Given its low stock price and debt pile equating to roughly three times its market cap, FCF will prove vital.

What Are CHK’s Options?

With the recent surge in oil prices and natural gas prices holding steady, one would think this would be good for CHK stock. Indeed, it is and Chesapeake has rallied as a result. But not all the gains in oil prices will fall to CHK’s bottom line right away.

It’s got a lot of hedged positions for this year and into 2018. On its conference call, management said:

“We have 579 bcf of gas, of 2018 production gas hedged to $3.10 per mcf and nearly 21 million barrels of our 2018 oil production hedged at $51.33 per barrel. Further, we have significantly reduced two of our more volatile basis pricing exposures for 2018, in-basin Marcellus gas sales and LLS oil sales out of the Eagle Ford.”

So while this limits some of the upside of Chesapeake’s earnings, revenue and margins, it also guarantees a good portion of its business too.

Continued rallies in commodities will allow for wider margins to fall to CHK’s bottom line. This is essential for a rebound in FCF and for CHK to get back on track.

The Bottom Line

With a further rally in energy prices, we should see CHK stock price rise as well. $4.50 is stiff resistance and $4 is no piece of cake either. If the stock can push above $4, $4.50 will be in its sights.

I worry about the large debt load and restrictive nature of its current financial position. Chesapeake isn’t out of time yet, but it’s borrowing it at a hefty price.

Eventually time will run out if it doesn’t improve its business structure. It needs some luck thrown its way in the form of stable and/or rising energy prices. If that’s the case, CHK can get back on track.

A major correction in energy prices would obviously be concerning, though. For longs, look to see how $4 fares for CHK. It breaks out, investors can consider buying CHK stock with a stop-loss on a close below its downward trend line.

Big-time support near $3.50 can’t give out and if it does, I wouldn’t stick around.

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.

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