Chesapeake Energy (CHK) has been stuck in a stock price range of $15 to $35 for the past five years. The stock spent most of the time between $15 and $25. It is now trading at less than half of its all-time highs from 2008 and it has lagged the S&P 500's performance. What will allow the stock to break past $35 and outperform the market? I will explain how the company is likely to get back in vogue and outperform the market in the next few years.
Lower Operating Costs
Chesapeake has reduced its workforce by 20%. This "rightsizing" of the company will allow it to operate more efficiently with lower operating costs. The lower costs associated with a reduced workforce will also make the company more competitive by increasing its gross margin, leading to higher earnings growth.
Chesapeake should also benefit from higher operating efficiencies with respect to its wells. The company expects to save $1 million per well with these efficiencies. Effort is being made to reduce cycle times for drilling, completion and hookup/field gathering. This will lead to improved cash cycle times to obtain its initial cash investments.
The increasing use of multiple wells on one pad will also lead to more production efficiencies to reduce costs. Once a well is drilled, the rig only has to move 20 feet to drill the next one. This reduces the costs of drilling the next well. This also reduces the impact on developable land and cuts down on truck traffic - a win-win situation for Chesapeake and the areas surrounding its wells.
The Upcoming Energy Bull Market
As the economy continues to improve, the energy sector should pick up. The energy sector is fueled by economic growth with more demand needed for utilities, transportation, etc. The Federal Reserve plans to taper its bond buying program in 2014 acknowledging that the economy is strengthening, but not ready to thrive on its own. The fact that economic growth is strengthening should be bullish for the energy sector, which lagged the S&P 500 for the past two years.
Chesapeake stands to benefit from economic strength as its natural gas is used more by utilities to produce electricity. This will be fueled by businesses adding shifts and ramping production to meet increased sales demand.
I'm looking more at long-term economic growth to benefit Chesapeake rather than relying on the unpredictability of cold or mild winters to benefit the company. December's cold weather in the U.S. has led the price of natural gas to remain above $4. This has led many to believe that entire winter will remain cold with traders betting on that theory. However, such trading is more of a bet than an investment strategy for the long-term. I would rather invest on longer term trends instead of the unpredictability of the weather. With that in mind, the NYMEX futures are suggesting that the price of natural gas will average $4 through 2014. Looking longer-term, the price is expected to remain above $4 through 2020. The forecasted price is based on a likely supply/demand balance based on production and economic growth. This should be a profitable price level for Chesapeake.
Chesapeake is currently priced at an attractive undervaluation as it trades at 12.6 times next year's expected EPS. The low PEG ratio of 0.30 reinforces this undervaluation. The company's high expected annual earnings growth of 54% for the next five years should catalyze the stock for strong growth. The growth should be achieved via lower costs and an improving economic outlook.