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I really like Chesapeake Energy Corp (NYSE:CHK), the producer of natural gas, the heating fuel used by most folks in the US and for many electric power plants. Chesapeake is a newer player in the commodities industry. It went public in 1993, then almost sank in 1997-8. But its leaders, CEO Aubrey McClendon and COO Tom Ward (now retired) saved the ship, rerouting its path and turning it into the largest natural gas producer in the US.

Most of its drilling is concentrated in areas in Arkansas, Texas, Oklahoma and Kansas, allowing it great economies of scale. Chesapeake has also been aggressively acquiring new companies in the area (a massive $8 billion worth since 2002), causing its output to rise at an average pace of 37% in the last 3 years.

In 2005, it bought Columbia Natural Resources, a $2.2 billion reserve outside of its usual map: an area from New York to Ohio to Kentucky and West VA. A massive purchase like this relies on natural gas prices to remain high to pay off. I feel that a much safer strategy would have been to continue producing gas from their reserves in the south, rather than banking on the potential hiding under costly land. That said, it could pay off in spades. Time will tell.

But management and financials are rock solid on this company. Wisely, Chesapeake has hedged a substantial portion of their natural gas production. In 2006, for example, CHK hedged 80% of their gas production at $9.45 per thousand square feet. So when gas is selling on the market for less (right now, analysts are predicting that 2006 natural gas prices to average at about $7.51 per thousand cubic feet on the spot market this year, and currently spot prices have fallen down to just under $5 range), Chesapeake is earning greatly more than its competitors.

Commodity stocks like Chesapeake tend to be valued in direct proportion to the price of natural gas, which doesn’t always take into account factors like hedges. Given its hedging program (more than 70% of its production through 2008 is hedged), you are currently getting more value than the analysts’ estimations may indicate with Chesapeake.

Type of stock:
A commodities stock in the natural gas industry, Chesapeake is making impressive gains, and has smart management and strong financials. While the recent large acquisition of Columbia Natural Resources is a big risk, CHK’s aggressive hedging program mitigates some of the risk.

Price target:
Currently trading in the $28 range, CHK is near its year low, having been at a high of $40.20 in the last 52 weeks. I think it is a great value at this price and would grab it now. While all commodities are risky, I am betting it is going to continue its impressive growth in the next several years.

CHK 1-yr Chart

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Source: Chesapeake is a Natural Pick in Natural Gas