Chesapeake Energy Continues to Shore Up Its Balance Sheet

I  commented on Chesapeake Energy (CHK) a few weeks ago so other than a brief Q3 update here, I refer you to that post.

The company’s cash flow is still holding up with OCF in at $1.4B, basically even from last quarter and up about 25% y/y.  CHK is slowly working to cash flow neutral as they only outspent OCF by $300M, compared to over $1.2B  back in 2007.

After the credit crisis, management started paying attention to its balance sheet and liquidity.  Cash jumped to $2B (from zero in Q2) and for the first time since I’ve owned them, their current ratio is over 1.0.  Also, the company drew down the rest of its credit facility ($1B available at Q2 08) and put it into money-market funds, Treasurys, etc., on worries the banks may not have the money when needed.   Keep in mind CHK has roughly $5B in off-balance sheet future obligations due to equipment leases, VPP purchase obligations, etc.

The income statement reflects the huge swings in nat gas prices and the related hedges that CHK have on.  Operating expenses are down slightly from last quarter and on the conference call, that’s a trend that management said should continue as the industry tamps down capacity.

Chesapeake seems to be managing the credit crisis well.  As of the 10-Q filing on Nov 6th, CHK had $800M cash on hand.  Their midstream subsidiary obtained a $460M credit facility, with $378M remaining.  The company also transacted a few small debt redemptions and modifications.

Subsequent to Q3, Chesapeake announced another JV, this time in the Marcellus Shale with Statoil (STO).  This transaction nets them $1.3B cash upfront with STO paying the majority of the exploration costs to exploit the assets up to $2.1B .   I direct readers to the press release for more details.

In summary, management has recognized that the market will continue to punish CHK until its fiscal house is put in order.  CEO McClendon and team are executing the plan to do just that.  In addition to the STO/Marcellus transaction, CHK is still trying to close sale of additional assets in South Texas and another VPP transaction.  Meanwhile, production is humming along — Haynesville has already exceeded previous stated targets of 75 mcfe/day — and proven reserves were down less than one percent despite the various asset divestitures. Impressive.

The Marcellus JV news release points out that implied value of CHK’s interest in the three JV shale plays (Haynesville, Marcellus, Fayetteville) is over $40 per share.  These were transacted in good times earlier in the year as well as just this past week in rocky times.  

Incredibly, this excludes CHK’s formidable position in the Barnett as well as its other plays.   CHK closed the week at $21 but I think CEO McClendon has “cracked the code” on getting its share price back up and seems to be well on his way to shoring up the balance sheet.  There’s also some talk about Chesapeake being a takeout target but I can’t imagine Aubrey selling for less than $60 per share.  I wouldn’t like any deal under $70 as I think the long-term value is intact and their capital position is looking better each quarter.

Performance measurements:

• Meet cash flow projections (lowered due to hurricane shut-ins and lower prices):
  • 2008 Q4: $1.250B - $1.375B  ($1.375B - $1.425B)
  • 2009: $5.4B - $5.7B ($5.8B - $6B)
  • 2010: $6.25B - $6.75B
  • FCF positive by 2010
• CapEx (do not outspend cash resources in 2009/2010)
  • Q4 2008: $1.6B - $1.8B
  • 2009: $5.7B - $6.5B
  • 2010: $6.1B - $6.8B
• Asset monetizations:
  • CLOSED ($150M) Misc OK assets: 2008 Q4
  • S. TX assets: Nov 2008
  • CLOSED ($1.25B + drill carry) Marcellus JV: Nov 2008
  • CMP partner: 2008 Q4 - 2009 Q1
  • VPP#4: 2008 Q4
  • Q4 2008: $2.5B - $3B
  • 2009/2010: $2.3B - $3.3B
• 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 for 2009/2010 ($2.50 - $2.70)
  • DD&A (non-oil/gas): $0.20 - $0.24
  • interest expense: $0.50 - $0.55

Disclosure: Long CHK

Comments

[Mmarrkk:]

Great summary. Now its time for the obligatory "CHK has too much debt" and "CHK is going out of business" that generally follow any article concerning CHK. Of course, none of those posters can ever really tell you what level the debt is, when its due, what the loan covenants involve and what triggers them, etc. Not to mention that most of CHK's gas is still selling for north of $9 vs current market prices of $6.50.

Be patient, bide your time. This stock will go back up faster than the market ever will. Or, would you prefer to buy some GM or AIG??

2008 Nov 17 11:25 AM

[jimmy46:]

good blog,
thx

2008 Nov 17 02:04 PM

[buyforeclos...:]

green is out of favor..this could see 16

2008 Nov 17 06:24 PM

[Mmarrkk:]

We've come a long way when an oil/natural gas company is called "green"!! Thanks buyforeclosures. You've added a new level to those I'll pay no attention to!

2008 Nov 18 10:32 AM

[smgilb:]

Good article. First & foremost, CHK got tarred through association w/Aubrey McLendon's margin call and liquidation of the stock. Not to mention that a forced sale played havoc w/the stock price.

Secondly, mgt. ran a little too aggresively versus cash flow available - hence the need for asset liquidations and partnerships. However, Aubrey did recognize value and went after it in a big way in the Haynevilles and Marcellus. These values have been demonstrated by public sales.

Contrary to those panicky parties that think CHK flirted w/bankruptcy thru loss of liquidity, reality was very different. Cash flow, protected by a strong hedging program, is and remains strong. CAPEX is flexible even after discounting contractual obligations for drilling rigs and service and held by production leaseholds. CAPEX will always be adjusted to the level of required corporate liquidity.

The street always worries about reliance on one off events, ie. assets sales as a source of cash vs. sustainable and ample cash flow BUT the bottom line is whether CHK is better or worse off by having been aggressive in its acquisition the Hayneville and Marcellus properties. I think the resounding answer is better off, by far.

CHK is incredibly undervalued versus hedged cash flows and assets in the ground. However, assets in the ground will be valued, for the time being at prevailing land costs which reflect current gas prices. This sort of stock is only for the patient investor (which I am). As long as there are occasional price spicks that present good hedging opportunities CHK will be OK and will thrive.

Furthermore, CHK's land purchases are probably over. Next step is the inflection point where the company is cash flow positivie and able to pay down debt, and eventually repurchase stock. The current meltdown will defer this event but not indefinitely.

As much as I am a believer in free trade, I'd rather see CHK adopt a poison pill since I want to capture the upside for myself and not yield it to some corporate purchaser. Aubrey has done a good job. He needs to do a better job of explaining his story. Less hype and more anlysis is the order of the day.

2008 Nov 18 05:04 PM

[BrotherMaynard:]

A little common sense goes a long way here. Berkshire hathaway is arguably one of the most well capitalized companies on the planet and they are getting hammered by credit markets...with $40bn in cash.

The fact that CHK is levered 1.5x, and runs a perpetually diminished cash balance, should be viewed as totally unacceptable by any prudent investor...esp. those investors that give two bits about management. Its the hubris of management that will kill this company, as they fail to care or believe that Nat gas sunk to as low as 2.50 during the last recession (and that was not a consumer led recession). Lord knows demand isn't going to pick up in this environment save for a ridiculously cold winter (4 months out of the year), but even then, industrial capacity is being laid idle writ large....yet supply is at levels net seen in a long time (b/c of finds like CHK's). We can't export the stuff (need LNG capacity for that...and its as big an eyesore as refiners, apparently), so we have to deal with what we pump. As a result, Raymond James made this prediction:

"With the exception of a brief winter spike, US natural gas prices will
have to tank in 2009 to rebalance a glutted market...[RJ's] model, which is based on 30-year average weather, shows the US reaching a theoretical 4.25 Tcf of gas in storage at the end of 2009's injection season based on gains in US production and a slackening of demand in a weak US economy... "This cannot physically happen (due to storage constraints)," Adkins said, noting that there is only about 3.75 Tcf of US gas storage available. "This means that gas prices must fall sufficiently to whack the gas rig count and force some producers to shut in gas production over the next year. For that to happen, the gas market will need to take prices even lower than our current forecast to rebalance the system."

Meanwhile, addressing the covenants that mmarrk is complaining about, we will cite a Johnson and Rice piece from 10/13/08:

"The key covenant is the debt-to-EBITDA ratio which is maxed out in the covenants at 3.75x. As of September 30, 2008, this stood at roughly 2.05:1...to push CHK into violation of this covenant, we estimate that all hedging positions must be lost (failure of counter parties?), not just the knock-out provisions, and NYMEX gas and oil prices would have to fall to $4/mcf and $60/bbl for a prolonged period, basically a doomsday scenario."

So there you have it. $4 is more real than anyone wants to admit given the RJ comments and where nat gas went last recession. $60 oil has been breached.

You have been warned.

2008 Nov 19 08:55 PM

[BrotherMaynard:]

fyi...here is the RJ news piece via platts that i cited above:

www.platts.com/Natural...

2008 Nov 19 08:56 PM

[BrotherMaynard:]

Furthermore, there are PLENTY of other companies out there that aren't even close to violating covenants (maybe or maybe not in the energy sector) yet trade at similar if not even more distressed valuations...so its time to move on folks. It was a bubble. Let it go!

2008 Nov 19 09:18 PM

[SlipperyWing:]

Debt is one thing, being mortgaged to the hilt is another.

There are contractors (contract tool pushers, welders, excavators, etc) and service companies (SLB, HAL) in Oklahoma who have not been paid by Chesapeake in over 12 months. There are also working interest holders that have common interests with CHK that have not been paid for production in over 12 months (a 6 month lag is more typical).

Chesapeake is essentially holding their money interest free, and have no desire to pay out.

I suspect that you'll hear more about this trend after January 1st, when it makes sense for third parties to start demanding their money (why demand money in December and pay taxes on it for all of 2008).

Chesapeake is in deep trouble, and their cash on hand won't even service their debt, much less pay off common interest holders.

2008 Dec 02 10:16 PM

[mcadoo3312:]

Do you have proof of this? What does their receivables schedule look like as there is not much of a difference between A/R and A/P.


On Dec 02 10:16 PM SlipperyWing wrote:

> Debt is one thing, being mortgaged to the hilt is another.
>
> There are contractors (contract tool pushers, welders, excavators,
> etc) and service companies (SLB, HAL) in Oklahoma who have not been
> paid by Chesapeake in over 12 months. There are also working interest
> holders that have common interests with CHK that have not been paid
> for production in over 12 months (a 6 month lag is more typical).
>
>
> Chesapeake is essentially holding their money interest free, and
> have no desire to pay out.
>
> I suspect that you'll hear more about this trend after January 1st,
> when it makes sense for third parties to start demanding their money
> (why demand money in December and pay taxes on it for all of 2008).
>
>
> Chesapeake is in deep trouble, and their cash on hand won't even
> service their debt, much less pay off common interest holders.

2008 Dec 05 03:42 PM