Despite rising oil prices, Chesapeake Energy (NYSE:CHK) remains in a funk. CHK stock, which had rallied to as high as $8/share in 2016, has plunged again. It’s right around the $3 mark, down 25% so far in 2018 and 46% over the past 12 months.
Sadly, for CHK stock investors, things are likely to stay rough for at least awhile. The company has a massive debt load, natural gas prices are heading in the wrong direction, loyal shareholders are starting to sell and analysts are downgrading the company left and right. Add it up, and there is good reason to avoid CHK stock, even after its recent decline.
Still No Cash Flow
It’s remarkable how long Chesapeake has run without generating positive cash flow from operations. For an energy company, once the wells are up and running, you generally hope to get a decent return on your upfront investment. That has not happened for Chesapeake yet.
From 2012 onward, the company has consumed $1 billion or more of cash in operations each and every year. Management sees that number dropping a lot this year, but still expect the company to burn through several hundred million more dollars.
Longleaf Throws in the Towel
Asset manager Longleaf Partners announced in its just-released client fund letter that it liquidated its stake in CHK stock last quarter. That’s a bad sign for the bulls on the stock.
Longleaf has been a long-time champion of CHK stock. It was one of the firm’s top three holdings dating back to at least 2013. This past quarter, it sold its CHK stock position for a 65% loss, according to the letter. In it, Longleaf wrote that management: “grew value per share where they could control it, but the present and future impact of Permian associated gas production on the long-term natural gas futures price swamped their great efforts.” Just look at the United States Natural Gas Fund, LP (NYSEARCA:UNG) chart over the long term to see what Chesapeake is up against.
Simply put, Chesapeake couldn’t outrun the falling price of natural gas. Fracking changed the North American energy landscape permanently. The glut of natural gas has simply driven prices too low for highly-levered operators such as Chesapeake to thrive, particularly if they don’t have sufficient exposure to oil, where pricing is far stronger.
The Wall Street analysts, as a group, have been a pretty patient bunch when it comes to CHK stock. But even they are starting to lose confidence in the turnaround story.
Citigroup, for example, nailed CHK stock with a nasty downgrade last week. It cut CHK stock to “neutral”. More painfully, it slashed its price target from $5/share all the way down to $2, representing another 30%+ downside from current prices. Why’d it cut CHK stock’s price target so much?
Citi cut its forecast for 2018 natural gas prices to $2.75/MMBtu, down from $3, in addition to slashing its 2019 outlook from $3.35 to $2.60.
Chesapeake management keeps talking about how they are lowering their costs going forward. And they’re doing good work on that front. However, other producers are making similar cost-saving moves. As a result, the industry is in a race to the bottom where production levels are too high, but no one wants to stop producing first. Production levels stay up, and prices keep dropping.
It’s a treadmill, and Chesapeake hasn’t been able to run fast enough to reach profitability. It’s also worth considering how much a drop in natural gas prices affected Citi’s outlook. Its modest 2018 cut and more sizable 2019 reduction led to the company’s model showing CHK stock losing 60% of its value against prior estimates. That speaks to the excessive leverage and risky nature of CHK stock.
Additionally, last month, Bob Brackett of Bernstein cut his outlook on CHK stock. He dropped his price target to $2.50 and issued a rare sell recommendation. He said that Chesapeake needs $3.25 or higher natural gas prices to succeed. Given where prices are now, he said that it is “difficult to envision a sustainable macro environment that would allow Chesapeake to thrive.”
Yet More Asset Sales
Under prior management, Chesapeake substantially overleveraged its balance sheet, making huge bets. Unfortunately, oil and gas prices collapsed, leaving the company with a ton of debt and not nearly as much revenue as expected. For years, the company has been trying to unwind the damage caused by its previous gambles.
The easiest way to shore up the balance sheet is by selling off assets. And in fact, that’s what Chesapeake has been doing. But here’s the rub: During a down market for natural gas, it’s hard to find bidders willing to pay fair prices for Cheaspeake’s properties. There are lots of bankrupt or on-life-support exploration and production companies out there. The players that do have cash can afford to be picky in buying properties off Chesapeake or other struggling firms.
CEO Doug Lawler recently claimed that the company won’t sell off more assets indiscriminately. Lawler stated: “We’re not desperate to sell assets, […] we know we need to improve the balance sheet, but we don’t have to sell anything in the near term.” However, with the debt load still at $10 billion and interest rates/credit availability getting more challenging, Chesapeake will continue to be a seller for some time.
Final Verdict on CHK Stock: Stay Away
I know CHK stock may seem cheap at $3/share and way down from its highs. But the low share price is deceptive. In fact, the company has $10 billion in debt and a nearly $3 billion market cap on top of that. All told, the market is valuing this company — which has lost $1 billion+ in cash flow every year dating back to 2012 — at $13 billion. That’s far from cheap. In fact, it’s a rather large speculation on natural gas prices recovering.
But why should they, at least in the near term? America has huge natural gas reserves and a ton of desperate energy companies that will keep producing to avoid bankruptcy. The fundamentals here simply don’t justify trying to catch the bottom on Chesapeake Energy stock yet.
At the time of this writing, the author held no position in the aforementioned securities. You can reach him on Twitter at @irbezek.
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