Reading the latest news on Chesapeake Energy (CHK) might lead an investor to mistake the Oklahoma based oil and natural gas company for a real estate play. In many ways the company could be seen as a real estate investment given how much of their success and strategy is governed by the divesting and acquisition of real estate. One piece of land at the center of this discussion is the Utica drilling site in eastern Ohio. The company expects a surge in output at the site, which is home to 240 wells, only 54 of which are in production.
The planned increase comes amid a tumultuous time for the company that recently saw the exit of co-founder and CEO Aubrey McClendon. He began the company in 1982 and today CHK is the second-largest natural gas producer and a major player in oil production. The acting CEO Steve Dixon now has his focus on reaching a daily natural gas output of 330 million cubic feet. This goal would more than triple their current production in the Utica region. Their renewed commitment to the project is most readily seen in their decision to "sell $12 billion in pipelines, oilfields and other assets in 2012, short of McClendon's original sales target, as a cash flow shortfall threatened to derail drilling plans and erode the company's compliance with lending covenants," as reported by The Wichita Eagle.
This cash flow shortfall was reportedly as high as $22 billion. The cause is frequently cited as falling natural gas prices. A portion of the $12 billion sale came from its holdings in Global Infrastructure Partners. Selling these assets means not only freeing up much needed cash but also reducing ongoing expenses associated with the operations and equipment.
CHK's focus on Utica also comes after a significant change to the management. Former CEO Aubrey McClendon retired in early April. His departure from the company likely didn't surprise many investors. In June of 2012, shareholders quickly voted down an executive compensation package with only 20% of the votes in favor. Shareholders made their disapproval clear and as one Wall Street Journal writer explained, "compensation wasn't alone in drawing shareholder ire. Two Chesapeake board members got less than 27% of their uncontested vote. That comes even after Chesapeake had promised to strip CEO Aubrey McClendon of his chairmanship and put on four new fresh faces, giving shareholders control of the board." This change coupled with the sales of various assets call into question the future earnings prospect of the energy giant. If investors were not confident perhaps these decisions deserve a fresh look at the company.
A look at the financials reveals some challenging years right up to 2012. The free cash flow has been negative since 2006 and EPS dipping into negative territory for the first time in 9 years. These numbers reassert the necessity of the changes outlined above. Some have recognized the inherent value of a company the size of CHK and the strength of management claiming, "with each new sale and joint-venture deal, Chesapeake is slowly digging itself out of its massive debt hole and resembling a powerhouse in the energy space. With huge land holdings in some of the most promising shale plays in the United States, Chesapeake still has enormous potential." Investors may be wise to take note of CHK's story arc. The fundamentals are strong yet the share price remains depressed offering potential value. The company has regularly paid a dividend that has increased since 2003.
However, it is important to remember how natural gas prices will influence shareholder value. These driving factors seem promising given the reports that "the company is already offering contracts for gas in 2014, at prices above $4 per thousand cubic feet. Prices last year were closer to $2 per thousand cubic feet, too low to cover the cost of drilling and produce a profit." Given these forward-looking contracts the time to strike might be now. Investors can expect to find real value at the intersection of the opportunity seen in natural gas prices and a well-established company that offers infrastructure, history and fundamentals.
This focus on the energy market continues to elucidate promising news for potential investors. Earlier in the month Jeremy Grantham, noted investor and co-founder of Boston-based asset management firm Grantham Mayo van Otterlo, remarked, "investing in natural gas at today's low prices is a no-brainer because the fuel, now in a glut because of surging supply from new fracking technology, will eventually flip to a shortage, bringing large gains for properly positioned portfolios." This outlook is likely shared by CHK as seen by their intensified focus on natural gas. Dixon himself said, "we will remain focused on increasing our liquids production, driving capital efficiencies across our business and enhancing our financial flexibility to prudently fund our future growth."
Furthermore investors should be pleased by Dixon's commitment to reducing their spending which has grown dramatically year over year since 2003. He asserted, "we're also making great progress in cost reductions and are on track for our lease operating and G&A (general and administrative) expenses to come in at or below budget this year." Given that revenue has grown year to year since 2009 it stands to reason that if these cost cutting measures can allow CHK to hold on to more of this money they stand to compound their earnings from rising natural gas.
A strong management coupled with favorable energy markets and improved operation efficiencies spell value, albeit long-term value, for investors.
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