Some analysts like the strategy Chesapeake Energy (CHK) is working with: Sell off "non-core for core" assets (what management calls its key drilling sights) and increase production of gas and oil. With a fresh new $3 billion dollar loan afloat from Goldman Sachs, the company plans on being able to meet capital spending needs even though it is expected to have a short fall in cash flow for the next couple years. Cutting expenses is a given! Let's take a look at this strategy and see what the company has going for it.
Funding Gap 2013
In the first quarter, Chesapeake Energy estimated that its spending commitment will exceed its cash flow by $3.5 billion for the year. For those of you who follow CHK this is not new. The company planned to rein in that deficit by selling oil fields and gas processing plants. Since the beginning of the year the company has divested itself of about $2 billion worth of assets. At the same time the company has also raised its oil and gas production estimates for the year and plans to continue increasing this into 2014. Citigroup analysts applauded Chesapeake's plans, but I don't know if this really means anything. It is obviously a sound plan but it's also just common sense that this is what the company should be doing. So applauding the company may be nothing more than good ambassadorship.
In terms of real numbers, the company set a goal to sell ($4 billion-$7 billion) in assets in 2013. It seems to be on track for the lower estimates because it already has sold $2 billion worth of assets that I previously mentioned. There are two other assets the company is expecting to close this year:
- Mississippi Lime joint venture transaction with Sinopec before the end of the second quarter. Total considerations for this transaction are up to about $1.02 billion in cash.
- Expect to sign agreements to sell our northern Eagle Ford Shale assets.
The company said it plans on devoting 80% of its capital expenditures on drilling and completion of activities in 2013. This is a different strategy than it has done the last three years when about 50% of expenditures were focused on these things. At the same time the company has been successful in reducing costs. Production expenses so far have been down 18% and general and administrative expenses have been down 29% year-over-year. It has done well so far controlling costs and become more efficient in its production. For this reason, these decreases in expenditures are estimated to save the company $130 million for the year. This is a far cry from the billions in shortfall that are expected, but we've got to give the company credit for moving in the right direction.
Moody investing services believes Chesapeake will be able to improve its leverage metrics in 2013 and through 2014 by a combination of paying down debt and increasing production. Natural gas prices have been higher in 2013 and with the increase in production, its cash flow will look much stronger. Its debt is expected to decline towards $12/boe through the second half of 2013.
Through 2014, a combination of asset sales plus $3.0 billion in available loans should keep the company afloat. This means anticipated capital expenditures that outstrip cash flow projections should be covered. This sounds good, but it's going to be a little bit harder than I describe. The company is going to have to continue selling other assets in order to maintain debt reduction and the ample flow of available monies to borrow.
This is going to be important. It seems like analysts and some rating agencies like the company's recovery plan. Now that new management is in place I believe analysts and investors alike are expecting the company to be a little more conservative than it has been under the previous regime. So the strategy appears to be working, but it's fragile. Selling assets for the next couple years to balance out capital expenditures, production and cash flow, will be the key.
Higher Natural Gas Prices Will Help
A catalyst to the increase in natural gas prices in 2013 is the transformation by electric companies from coal to natural gas generated electricity. The switch has been taking place for two reasons: the advantage of the low prices and the cleaner burning natural gas fuel.
Another factor in the price increase of natural gas will be regulations put on plants. New EPA regulations coming into effect in 2016 could render as many as 56% of all coal producing electric plants not cost-effective to run with coal. EPA pollution standards will cause more and more plans to convert to natural gas and away from coal. This could easily lead to three times the amount of natural gas being used in the near future.
Chesapeake Energy appears to have a sound plan to try to get itself on track. Although analysts appear to support the plan, they fall short of putting their reputation behind it by leaving the company with a "neutral" rating. I can't blame them as I am also conservative on my outlook for the company. It plans to move forward by reining in expenditures, selling non-core for core assets and raising production is a good strategy to bring it back on track.
A lot rests upon the company's ability to be able to sell those assets. This is vital over the next couple years, but I believe that a continuing increase in natural gas prices will also be a great shot in the arm to the company. It's not going to be easy over the next couple years and the economy needs to help Chesapeake along. I believe if things go right for the company, by 2015, 16 we may see a strong foundation and the growth of a well run company.