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By: Ahmed Ishtiaq

Chesapeake Energy (CHK) has been through a lot recently and lost a considerable value due to some concerns about the debt. In the most recent earnings announcement, the management indicated that assets sales could be delayed. The company is trying to raise cash by selling assets to pay off some of the outstanding debt. Chesapeake stock is beaten down badly at the moment by the bears, which I believe presents a great opportunity to long term investors.

It is true that there have been concerns about the corporate governance of the company, and it can certainly not be called a champion of corporate governance. However, necessary steps have been taken, and the company is moving in the right direction. There have been some significant events since the earnings announcement. Let's take a look at those events and their expected impact on the stock.

Betting on a Colder Winter:

According to the reports, Chesapeake is going to go into the winter without hedging its position against the commodity prices. At the time, when most of its competitors are establishing hedges to safeguard them against the volatile commodity prices; it can be a massive risk. According to the reports, the CEO Aubrey McClendon is expecting the cold winter to drive natural gas demand. As a result, the gas prices will show a significant recovery. On the other hand, if the bet pays off, it can prove to be an excellent decision. There are mutterings of a colder winter as compared to the previous year, which has caused the gas prices to rally. There are still fears that new pipelines will result in increased supply. Record high storage and increased supply can cause the gas prices to remain low.

In a previous article, we discussed the situation of oversupply, and how leasing system in the country pushes the participants. According to the lease agreement, the companies have to drill quickly or surrender the drilling rights. This is exactly what is happening in the sector. At Eagle Ford Shale, most of the companies are drilling gas wells just to meet the lease obligations. At a time when the sector is already facing a problem of oversupply, these lease agreements are not helping these companies. However, most analysts believe that the colder winter will have a bigger impact than an increase in the supply, resulting increased prices.

Increased Investment from the Big Boys:

Big investors are currently increasing their stakes in the company. Certainly, they see some value in stock at current prices. Carl Icahn increased his stake in the company to 9% from 7.5%. The main reason behind the recent slump in stock price was the fears about the debt and delay in asset sales. A delay in asset sales was expected due to the market conditions. However, it will not be long before the company sells its assets earmarked for sale and bring down its debt. The fall in price gave a great opportunity to these big boys to increase their stakes in the company. Carl Icahn has now spent $951 million building his stake in the company, and he remains the second largest shareholder.

Further, hedge funds are also loading up on Chesapeake stocks. Mohnish Pabrai, a hedge fund manager, recently increased Chesapeake stocks in his portfolio. At the moment, about 20% of the total value of his fund is invested in Chesapeake, behind only Bank of America (BAC) and Citi Group (C). I agree with these big boys, and believe that the fall in Chesapeake share price in temporary and it will recover in the medium and long-term.

Comparison with Peers:

Chesapeake peers include Devon Energy Corp (DVN), EOG Resources (EOG) and Exxon Mobil Corporation (XOM).

 

 

 

CHK

EOG

DVN

XOM

Forward P/E

15.60

17.50

11.50

10.70

P/B

1.00

2.30

1.00

2.40

P/S

1.00

2.80

2.30

0.9

EPS Growth

35.60%

-25.00%

N/A

-0.90%

Operating Margin

-14.90%

18.90%

10.30%

16.00%

Net Margin

-6.70%

10.50%

6.90%

9.10%

ROE TTM

-6.00%

9.10%

3.10%

27.50%

Debt to Equity

1.30

0.50

0.40

0.10

Source: Morningstar.com

The comparison shows that the stock is trading at a premium compared to Devon and Exxon Mobil based on forward P/E. However, the stock beats all of its competitors on P/B and P/S ratios. In addition, the company has the highest EPS growth rate among its peers. However, margins and the debt to equity ratio for Chesapeake do not paint a pretty picture.

Summary:

I believe the market has been slightly harsh to the company, and the decline in price is temporary. Chesapeake will soon sell some of its natural gas assets and reduce its debt, which will push up the price. Furthermore, an increase in demand during the colder winter will drive up natural gas prices. Chesapeake has also turned its focus to liquids, which will provide its revenues more stability. Overall, position of the company is improving, and the coming year should be good for Chesapeake. I expect the stock to remain low in the short term and recover in the medium to long-term.

Source: Chesapeake: A Great Long-Term Play