Chesapeake Energy Analyst Day Update: Company Moves to Resource Conversion

The financial media have been all over the story of CEO Aubrey McClendon being margined out of the vast majority of his CHK stake at massive losses.  Over the last few months, investors have watched CHK go from over $70 per share to near $10 (currently @ $20) which is even more drastic than the underlying commodity and other E&P companies.  Along with McClendon’s forced selling, concerns about Chesapeake’s exposure to dysfunctional capital markets drove CHK lower than its peers.

With that background, I reviewed CHK’s presentation from its recent investor/analyst meeting last week.  Specifically, I was keenly interested in CHK’s financial position, its ability to complete further asset monetization deals and its general operational outlook given the financial turmoil combined with the drop-off in nat gas price.  While I may go back and listen to the day-long webcast later, here are some key takeaways from the accompanying presentation:

• The company reported $1.1B cash on hand (10/9/2008) and expects to end the year with $3.5B.  This compares to Q2 2008 reported cash of zero.
• CHK has not been completely shut out of the credit markets as it closed a $460M credit facility for its midstream subsidiary, CMP.
• Chesapeake has hedged 73% of Q4 08, 69% of 2009 and 42% of 2010 production at prices of $9.19, $9.56 & $9.81 per mcfe respectively.  This provides confidence that the company can meet its tentative cash flow projections:
  • 2008 Q4: $1.375B - $1.425B
  • 2009: $5.8B - $6B
  • 2010: $6.25B - $6.75B
• Management plans on monetizing various assets in the near/intermediate term including another VPP transaction, finding a JV partner for the Marcellus shale similar to its deals with PXP & BP as well as a partner to help fund its midstream affiliate.  Projected cash inflows:
  • 2008 Q4: $2.5B - $3B
  • 2009: $2.25B - $3.25B
  • 2010: $2.25B - $3.25B

• Chesapeake is handily within its various debt covenants.  Further, the company has no maturing senior notes until 2013.

• Management has reverted to a more conservative stance.  It has scaled back capex budgeting and recently shut in production.  Management sees the credit crisis will reduce rig count even faster than the drop in nat gas price.
• CHK also project an imminent change in SEC reserve accounting rules which could lead to increase projected YE 2008 proved reserves from ~15 TCF to ~20 - 25 TCF.
• On previous calls, McClendon has brought up the possibility of LNG to export US nat gas.  Such a move would be a boon to the nat gas market, perhaps to the detriment of a country supposedly focused on “energy independence.” While management does not think that regulatory approval will be an impediment, I am more skeptical and am taking a believe-it-when-I-see-it approach.

While the correction in commodities has been painful, I remain bullish on the long-term fundamentals.  CHK, however, has always had more financial risk than its peers and as such, it is probably more important to gauge the company’s ability to weather the current credit crisis than the downturn in nat gas price.

It seems clear that CHK has changed course back to “resource conversion”, which it had just recently steered away from to exploit high prices and new discoveries.  At this point, while the company still has some important benchmarks to meet (listed below), I believe the company’s operational adjustments combined with its hedges will allow it to weather this storm.  It is a testament to the company that I am not worried in the least about hitting production or reserve targets.  That, in itself, is a strong statement about the attractiveness of CHK if it can successfully deleverage.

While I have not added shares during this decline, I did turn a quick 22% relative gain over a few days with some naked puts during the panic selling.  In adherence to my focus on dividends, I may buy some of the exchange traded preferreds for Chesapeake Energy.

Performance measurements:

• Meet cash flow projections:
  • 2008 Q4: $1.375B - $1.425B
  • 2009: $5.8B - $6B
  • 2010: $6.25B - $6.75B
  • FCF positive by 2010
• Asset monetizations:
  • Misc OK assets: 2008 Q4
  • S. TX assets: Nov 2008
  • Marcellus JV: Nov 2008
  • CMP partner: 2008 Q4 - 2009 Q1
  • VPP#4: 2008 Q4
• YE 2008 cash on hand: ~$3.5B
• 2008 production 851 - 861 bcfe
  • Barnett - 675 mmcfe/day by YE 2008
  • Fayetteville - 200 mmcfe/day by YE 2008
  • Haynesville - 75 mmcfe/day by YE 2008
• Hit reserves guidance @ 12-12.5 tcfe by YE 2008 & 13-14 tcfe by 2009 (they have already met 2008 target)
• Maintain 2:1 ratio on risked/unproved to proved reserves. Large decline may signal end of growth. This ratio is currently closer to 4:1.
• Operating costs (per mcfe):
  • G&A: $0.43 - 0.49
  • DD&A: $2.50 - $2.70
  • DD&A (non-oil/gas): $0.20 - $0.24
  • interest expense: $0.50 - $0.55

Disclosure: Long CHK.

Comments

[Paul Killinger:]

The government WILL adopt the Pickens Plan along with various mandates and tax credits for the future use of domestic NG. Chesapeake is positioned PERFECTLY to take full advantage of these developments. This could even result in its becoming the new Microsoft over the next several years. Think about that!

2008 Oct 27 11:21 AM

[scfranklin94:]

I wish the gov't would adopt the Pickens Plan, but I'm not a believer in the US gov't having any common sense. Basically, our gov't only responds to contributions from special interests.

2008 Oct 27 12:40 PM

[Road Runner:]

Good info. Thanks.

2008 Oct 27 03:21 PM

[Grampa Jim:]

Excellent analysis, Davy! Many thanks! I was really sweating gravy after that McClendon fiasco. I stand substantially reassured.

2008 Oct 27 03:33 PM

[jeff Ferrari:]

Marcelous shale is the largest natural Gas formation in the world and they are already making a fortune. I would buy CHK very soon. We will be rich..

2008 Oct 27 04:43 PM

[Joe V:]

Nice analysis, thanks!

2008 Oct 27 08:25 PM

[crude oil man:]

I would be concerned at this point concerning Kickout clauses in there hedged reserves. Was it 6.26/mcf?

2008 Oct 28 12:26 PM

[Diegojames:]

Thanks for analysis and explanation of CHK. Now I know why my investment tanked? AFter the 1 billion hedging loss there was something lurking and then selling assets to BP and now this insight,,,,,this is something of a CDO energy play.
There are many "what ifs.....should be....might be....." and we do need a PICKENS PLan is not sufficient reason for a large position here.
I am long CVX-XOM-OXY.
Diegojames
Porter Ranch,California

2008 Oct 29 10:06 AM