WTI oil at $61 and change has engendered frustration at the pump, but hope for a resurgence in commodities stocks and the energy sector in particular. Consequently, some speculators are pinning their hopes on Chesapeake Energy (NYSE:CHK), a cheap shale stock that tends to make outsized moves in both directions.
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I’m writing this on a Friday and the share price shed 9.5% today — not a great way to end the week for Chesapeake investors.
Just when you think the stock has found a bottom, cheap shares become even cheaper and support levels magically transform into resistance points. Sure, I love a good bargain, but have we yet plumbed the depths of this once-promising shale trailblazer?
The Big Shale Fail
Hype over the shale industry has come and gone, and Chesapeake unfortunately has become the poster child for a market in decline. Once trading above $62, CHK shares are struggling to break above $1. As InvestorPlace’s own Vince Martin reminded us, the company touched a paltry 55 cents on Nov. 19.
The oil price has pushed upwards since then, and that in turn has buoyed CHK shares for the time being. Still, the unpleasant numbers from Chesapeake’s third-quarter earnings announcement remain imprinted in investors’ memories. Upon digesting the stats, you too may conclude that an oil price breakout might not be enough to take Chesapeake shares to the next level.
As it turned out, virtually all of the results were worse than the already low expectations. Year-over-year production output declined by 11%, while Chesapeake’s adjusted third-quarter earnings loss came to $188 million, or the equivalent of 11 cents per share; disappointing as that was, it was actually 2 cents less per share than the analysts’ consensus estimate.
A major concern for investors is Chesapeake’s lack of cash flow; apparently in response to this, the company announced that it will reduce its spending during the coming year from $1.6 billion to $1.3 billion. That’s a 23% reduction and is a good start, but I wouldn’t say it’s quite enough to save a company with $9.7 billion in reported debt by the end of 2019’s third quarter (bear in mind that the entire company’s enterprise value is just $14.5 billion).
A 10-Q Shocker
I always tell investors that quarterly 10-Q reports are a must-read, and Chesapeake’s most recent filing is a textbook example of why this practice is so important. You might want to cover your children’s eyes as you take in this rather ghastly horror story, which would make Stephen King recoil:
If continued depressed prices persist, combined with the scheduled reductions in the leverage ratio covenant, our ability to comply with the leverage ratio covenant during the next 12 months will be adversely affected which raises substantial doubt about our ability to continue as a going concern. Failure to comply with this covenant, if not waived, would result in an event of default under our Chesapeake revolving credit facility, the potential acceleration of outstanding debt thereunder and the potential foreclosure on the collateral securing such debt, and could cause a cross-default under our other outstanding indebtedness.
“Failure to comply” in this instance is a fancy way of saying “insolvency” and a possible first step towards bankruptcy, unless a deus ex machina in the form of a corporate buyout saves the day. Betting on that is a lovely form of gambling but a terrible way to invest, so I’ll sidestep the takeover potential discussion and stick to the facts (maybe).
The oil price has improved since that 10-Q was released, but CHK shareholders have yet to forgive the company and I can’t say I blame them. The share price fumbled and stumbled while the underlying commodity itself rallied; should the oil price retrace its fourth-quarter gains, the damage to the CHK share price would likely be considerable.
The Takeaway on Chesapeake Energy
The moral of the story is to exercise daily, get plenty of rest, and always read your SEC filings. That 10-Q’s a doozy and less astute traders might have mistaken Chesapeake under $1 as a bargain. On the contrary, the company itself is practically telling us to avoid the stock.
With Chesapeake shares cratering even while spot oil prices drift aloft, it looks like cautious investors will have to drill for profits elsewhere.
As of this writing, David Moadel did not hold a position in any of the aforementioned securities.
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