Chesapeake Energy (CHK) is up 70% YTD. The Oklahoma-based oil and gas producer is still continuing with its restructuring process, which has so far seen 900 employees depart the company. Nonetheless, Chesapeake Energy's restructuring process has largely been centered around selling of long-lived assets, which include land containing oil and gas deposits.
Most of these assets were sold at a loss based on the economic valuation of the oil and gas deposits and the price paid for the land. However, the company is believed to have changed its strategy going forward, and is now expected to sell disposable assets at the right price. This is mainly because the initial pressure on the company's balance sheet has recently eased off. However, it is still a long way to go. Analysts from Citigroup upgraded the stock in a recent note to investors saying, "Chesapeake will likely look at paring assets to "reduce its financial complexity" over the next few years, but it is no longer under the gun to sell assets at fire-sale prices."
I believe that the company's recent change in strategy could yield more than just proceeds from the sale of assets. Note that the company's balance sheet is by no means off the hook, despite the fact that things have eased off. But it would be much better for the company if it didn't continually report loss on asset disposals on its income statement. This will help direct some more income to shareholders, while at the same time reducing on the amount of interest payable.
Chesapeake Energy expects to spend approximately $95 million in relation to employee lay-offs, and other executives departing the company. This is likely to affect operating income, but the long-term benefits associated with reduced workforce should be huge enough to justify the costs associated with the lay-offs. Therefore, Chesapeake Energy is certainly on the right track towards sustainable growth and increased shareholder value. The company holds massive amount of assets rich in natural gas and Natural Gas Liquids [NGLs], as well as oil deposits. In the most recent quarter results filing, Chesapeake's total net property and equipment stood at $37.3B, which is more than double its current market value. While oil, NGLs and natural gas prices may be slowing, history tells me that in the long run, energy prices tend to move north.
Therefore, the fact that the company is performing quite well in terms of market price under the current circumstances means that there could be even much better performance for Chesapeake Energy upon completion of the restructuring process and improved prices for its products. This indeed leaves a lot of room to outperform for the company going forward, which means, even at the current price of $28, the entry window is still open for aggressive investors that seek to ride on the impeccable value in the energy sector.
Chesapeake Energy Is Significantly Undervalued
Even without considering the company's growth potential, Chesapeake is substantially undervalued. While I consider the 2008 highs of mid $60s to be an outlier in the company's performance in the past and in the foreseeable future, the 2011 highs of mid $30s appear well within reach.
Chesapeake has been increasing its asset value over the last eight years. The company assets are a massive opportunity towards increasing shareholder value. In a recent presentation to investors at Deutsche Bank leveraged finance conference, Senior VP of Investor Relations & Research Jeff Mobley said:
"...what underpins your investment, is the foundation of great assets that the company has worked to build, particularly over the last eight years and what we amassed is what we believe is one of the largest, unconventional resource bases in the United States."
Over the last two years, the challenge has been that, a majority of its oil-filled assets remained unexploited as drilling was limited only to some. Note that there was massive borrowing involved when the company was acquiring these assets. Therefore, failure to convert them into cash generating projects has been a huge setback for the Chesapeake Energy.
However, the sell-off has eased that problem. Chesapeake now seeks to convert a majority of the remaining assets into cash generating projects. This is what is going to create shareholder value, and especially considering that plans are underway to level out cash outflows and inflows in the near term.
In essence, there is still too much value within Chesapeake Energy's grasp, which requires efficient management of resources and cost control. The company's new CEO should help bring this dream home while continuing to budget for a fully cash funded CapEx going forward.
Additionally, the company has also been refinancing some of its debt with notes containing more favorable terms, which again should help ease the interest expense burden.
Bringing these factors in the equation, I believe the company's P/B value of 1.42x indicates a significant level of undervaluation. I believe that Chesapeake Energy could comfortable trade at around 1.8x P/B within the next twelve months if it can even out its cash flows and convert unyielding projects to cash cows. This would translate to a price of about $35 per share or 25% upside. The company has a massive asset base, which should be the foundation of its sustainable growth and improved shareholder value.
Chesapeake Energy and its counterparts SM Energy (SM) and Range Resources (RRC) are relatively small players in the oil and gas industry, especially when compared to giants Exxon Mobil (XOM), Chevron (CVX) and BP (BP). However, Chesapeake can boast for having a massive asset base, at least in the U.S. Doing well in the oil and gas industry depends on the amount of fruitful assets/projects that a company owns. Chesapeake certainly has got lots of those, and could have even more if it manages to make good use of its underutilized oil and gas deposits. The company may not have massive deposits spread across the globe like its giant rivals, but for a company of its size $18.34B in market cap, the amount of assets it has are a statement that there is still room to outperform.