Introduction: When searching for and researching speculative equities, I look for shares that have value characteristics and that are off long-term prior highs but with recent upward price momentum. Then I want to see insider accumulation of the shares and a catalyst for possible strong upside price action, which could be the existence of a high short interest in the shares. These of course apply to favored turnaround situations.
This article reviews Chesapeake Energy (CHK) in that context.
Due to the upward move in energy prices the last couple of months, I have found this to have been a good trading vehicle; currently I am at a minimal position in this equity.
Background: Chesapeake is a U.S.-based land oil and gas producer with a natural gas focus. It is now a turnaround story. CHK was founded by a bit of an empire-builder, Aubrey McClendon. Mr. McClendon was forced out of the company recently under a cloud. CHK now has an unpaid chairman and a geologist CEO; both are industry veterans. Management now pledges to engage in investor-friendly actions. these include deleveraging the balance sheet primarily via asset sales, and more generally seeking to improve total returns for shareholders in the here and now rather than seeking to shoot for a more risky longer-term large success. The company is attempting to improve its operating efficiency and to decrease its dependence on natural gas and move more to oil and natural gas liquids production.
Seeking Alpha has published several articles on CHK over the past few months that happen to have relatively little overlap, and that collectively provide good fundamental information. I would say they have more of a bullish than bearish tinge. Multiple sources of information are available about the company, of course.
The reason I wrote this piece now and with the focus it has is to supplement the other recent Seeking Alpha articles. Also, given that I have mixed feelings about the stock, perhaps it could be useful for current or potential CHK shareholders to review the thoughts of this experienced trader. Note that I have no geologic expertise, and ultimately much of this company's value derives from technical factors.
In fact, Chesapeake has so many producing and non-producing properties that absent an expert review of its proprietary data, even an outside industry expert might have difficulty in fully understanding the profit-and-loss potential of these properties in aggregate. This is especially so given the unknown future prices of the commodities Chesapeake produces, and how the asset sale program will fare.
Conceptually, CHK can be considered for now as a proxy for the U.S. price of dry (conventional) natural gas, though as stated its focus has begun to change.
Let's start with some charts.
Technical chart factors for CHK: For a controversial company that has received a great deal of negative publicity for several years running, the long-term chart is strong, though exceedingly choppy. Even though the shares have come way down off their peaks and trade below a 1996 spike high, CHK ultimately shows a bottom-left to top-right chart (all charts are semi-log and are from Yahoo! Finance unless otherwise noted):
The annual compound price appreciation since the company went public in 1993 has been just over 15% per year. This is well above the performance of the average stock. So even though CHK's focus, U.S. land production of natural gas, has entered a pricing depression in recent years, and despite the company's high debt load and issues regarding Mr. McClendon, investors who committed to these shares when they came public and passively held have done well.
The one, two and five year charts (shown in that order below) are consistent with those of a turnaround situation. CHK may be making "the turn".
The stock has gone up over the past year, so a buyer now is not trying to catch a falling knife. The stock is also close to breaking out of a multi-month triple top. Might it be safer to wait to see if it can do so? So it would seem.
The 2-year chart shows that CHK has lagged a rising market, which puts it in the "possible catch-up" category. Not bad, especially given the pricing problems in natural gas over the same time frame.
The final, 5-year chart shows that CHK has been holding lateral support. It also shows that its post-Lehman low held on a test last year. This is similar to the action of other truly depressed stocks of troubled companies such as Bank of America (BAC), which got hammered in late 2011 back to $5, just above its spike low of 2009, then has been a strong performer.
CHK looks good in relation to its various moving averages, but it's unclear what that means in a strong bull market. I'll stop there and not engage in a discussion of short-term technical factors.
In summary, I am intrigued by CHK's basic chart pattern at every time frame shown. However, it has not truly "broken out".
Technicals for natural gas: CHK's value is heavily related to the current and expected future price for U.S. production of natural gas, which of course is unknown. The price charts for natural gas over one year, and for more than five years, shown below, show why CHK's chart looks as it does:
From FINVIZ, natural gas has had a strong one-year performance, perhaps beginning a rebound from a weak 5-year show.
Natural gas looks on the charts like a washed-out commodity. It made a marginally lower low last year compared with its 2009 low, and it hasn't broken upward resistance yet, but its underlying fundamentals are good. (In fact, they are so good that this point may fall into the category of a "known known" and therefore may be of no incremental value to an investor.)
With West Texas Intermediate oil (WTI) recently trading near $110/barrel, the energy content of natural gas makes it a bargain versus crude. Of course, natural gas burns more cleanly than crude, so it's preferred on that standpoint. Natural gas is much more expensive in most of the rest of the developed world than in the U.S. Thus there should either be declining prices "over there" or rising prices here, but only over time. Indeed, given its debt load, one of the key questions about CHK is whether it can shed debt rapidly enough to have the requisite staying power.
A secondary long-term positive may be the fact of large write-offs that several oil majors have taken on U.S. natural gas reserves. They say they need much higher prices to make developing their resources worthwhile. Because the companies were likely not insane when they acquired these properties, in time their purchases may prove to have been sensible. When, however, this may occur is another story. The U.S. Energy Information Administration has a chart and table of the multi-decade price trend in this commodity. Currently, it is up about 7X from its 1976 level. If one ignores several major upward spikes, the long-term price trend has been gently upward over these 37 years.
Can the fracking revolution keep the price around current levels year after year after year? We will have to wait and see.
Sponsorship and insider trading: This looks to be a material positive for CHK. Insiders have bought nice amounts of this stock around current prices, most notably a large purchase by Chairman Dunham, but he's far from the only one.
Very smart, activist value investors have accumulated CHK stock, and I hope they have not turned to sellers, or begin to sell, now that I have gone long with them:
As of March 31, Carl Icahn owned nearly 9% of CHK shares, and another well respected activist institution, Southeastern Asset Management, owned 13.4% of CHK's shares.
Despite the above, CHK is a heavily-shorted stock.
Most short-sellers do their homework. But, these same stocks have tended this year to have been especially strong performers lately, specifically due to short-covering. CHK is not a stock for the weak-kneed.
General fundamentals: CHK's book value as of 3/31/13 consisted of $15.7 B of tangible assets minus liabilities, with no intangible or goodwill assets on the balance sheet. As of Friday, July 19, CHK closed at $22.58 and a market value of $14.6 B. The stock is trading around 15X consensus earnings estimates for 2013 and 11X estimates for 2014. It also has been paying a $0.35/share dividend on an annual basis. It may be questioned as to why this debt-heavy company is paying any dividend; perhaps it's to allow more institutions to hold the shares.
There's much more to this company than the above fundamentals. My view is that they likely are "in" the share price, that the investment bottom line on CHK is that it's a speculation other than to pros such as insiders and the Carl Icahns of the world.
Risks: Significant and possibly existential risks exist here. The company has announced a major program to continue to raise cash to pay down debt by selling off certain of its properties. This may or may not come to fruition; failure in this regard could have serious repercussions to shareholders. Even if management meets its deleveraging objectives this year, the company will continue to have lots of debt. (The amount cannot be known until this year's asset sales are completed.) In any case, it is hostage to energy prices over the long haul. It may not survive in current form without major shareholder dilution or forced asset sales (or worse) to see the next major rebound in natural gas prices- if one ever occurs. Or, it may survive but simply find that it is not able to generate sufficient profits to justify today's market value.
All the other risks that occur with investing in any stock apply fully to this volatile equity.
Summary: Chesapeake Energy has several catalysts that might lead to strong upward price action, including a high level of short interest and possible upside volatility in natural gas pricing. The insider buying, new corporate leadership, and "smart money" stock accumulation that have occurred represent important investment considerations. So is the promise from the company's new leadership to put total returns to shareholders as their guiding light.
However, numerous and serious risks abound for this company and its shareholders, both regarding its heavy debt load and the profitability of its businesses even if it successfully sheds a lot of debt. I am long a small amount of this stock specifically to seek alpha within the setting of a conservative investment posture, and may sell the rest of my holdings or add more at any time, given that this neutral review of the company should not move the stock at all.
Overall, I find CHK to be an interesting high-risk stock that could be suitable for a buy-and-hold investor as well as for an active trader.