With the surprise retiring of Chesapeake (CHK) CEO Aubrey McClendon a few weeks back, will investors benefit from the company shifting towards a more disciplined strategy? Or will the company remain on the same collision course with debtors?
The company is the second-largest producer of natural gas, a top 15 producer of oil and natural gas liquids, and the most active driller of new wells in the United States. The company's operations are focused on discovering and developing unconventional natural gas and oil fields onshore with leading positions in the Eagle Ford, Utica, Granite Wash, and Mississippi Lime unconventional liquids plays and in the Marcellus, Haynesville, and Barnett unconventional natural gas shale plays.
While most investors don't doubt that Chesapeake owns the largest domestic oil and natural gas resource base, the question exists as to whether shareholders will reap the value of those resources due to a huge debt load.
Revised Capital Allocation Strategy
The company has long been its worst enemy. Throughout the last decade, Chesapeake has continued to find new shale areas and invest vast amounts of cash acquiring acres. Unfortunately, the more the company acquired and drilled on the less valuable each acre became. Remember that a resource only maintains a high valuation based on the scarcity of the asset. The more it found the less scare the resource became.
If the new CEO develops a strategy of reducing the debt load by disposing of assets and eliminating any land acquisitions, the stock might finally turn the corner. With a debt load of around $14B, the stock is loaded down with debt that isn't helpful.
As the company presented in the February investor presentation, it plans to sell another $5-7B in non-core assets in 2013. This on top of $12B of asset sales in 2012. The company hopes to enhance shareholder returns by leveraging all the strong positions in very valuable shale plays.
Chesapeake has 21.3 tcfe of proved reserves on 15.1M net acres of leasehold. While an impressive set of assets, the stock doesn't reflect this value due to the massive debt load and concerns that the previous CEO would continue to spend.
From a revenue standpoint; Chesapeake is one of the cheapest oil and natural gas producers in the country. The stock currently trades at nearly 1x revenue, but based on an enterprise valuation basis the stock isn't as cheap.
When looking at valuations for other independent natural gas producers such as Range Resources (RRC), Southwestern Energy (SWN), and Ultra Petroleum (UPL), the stock appears the cheapest. Not only does Chesapeake have a greater focus on liquids plays, but the stock also trades at a lower price to sales valuation. More proof that if the company would only focus on developing the existing asset base, the stock would soar.
As the chart below highlights, the valuation issue with Chesapeake isn't related to the weak natural gas prices. The issue is the debt load and the inability of the previous management team to grasp the need to be more prudent with the allocation of precious resources.
Based on the data provided by Chesapeake, the company has a very cheap valuation. As the below slide highlights, the stock trades at only 3.2x the estimated 2013 operating cash flow.
While McClendon might have been an expert on finding and building huge positions in shale resources, he struggled with satisfying the demand of investors. The public markets tend to prefer a consistent strategy such as those undertaken by Range Resources, Southwestern Energy, and Ultra Petroleum. Those stocks trade at much higher valuations.
The biggest risk with Chesapeake is whether the BOD will hire a new CEO focused on the development of the existing assets. The hiring of a crony baked by McClendon might lead the company down the previous path. A new, independent CEO is truly needed to send the stock higher.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.