Chesapeake Energy: Buy Now Before It Gets Too Late

| About: Chesapeake Energy (CHK)


Price performance of CHK has been flat year to date, presenting a buying opportunity for investors.

Fundamentals are likely to improve meaningfully in 2014 owing to improved production profile as well as management's effort to monetize non-core assets and refocus on key areas.

At just 0.6x PEG, the expected valuation multiple expansion and earnings growth should drive substantial price upside.

The share price of Chesapeake Energy (NYSE:CHK) has been trading range bound year to date. In my view, investors should pick up the shares at this level, as I expect the price to trend up later this year as valuation and earnings are driven by the company's ongoing effort to improve capital efficiency. My bullish view is based on the following reasons.

The company recently reported Q4 2013 results. Quarterly production declined by 1% sequentially but increased by 2% year-on-year. However, the sequential production decrease was largely due to asset sales. Adjusting for that, the quarterly production was actually up by 10% year-on-year. CHK managed to drive up NGL production by 9% year-on-year, resulting in an increase in liquid mix percentage from 23% in Q4 2012 to 26% in Q4 2013. Looking forward, management sees 2% to 4% growth in higher-valued commodities (i.e. oil and NGL) in 2014, and it is expected that this favorable trend would support top line growth and improve margin metrics in 2014.

CHK is expected to complete at least $1B sales of non-core assets in 2014. Management also recently announced a plan to divest Chesapeake Oilfield Services, which is estimated to be worth about $2B to $3B by analysts. Given this significant cash proceeds and CHK's estimated funding gap of approximately $450M in 2014, the company is believed to see a funding surplus in 2014.

Management's continued effort to divest non-core/inefficient assets allows the company to focus on its operations in key areas (e.g. Eagle Ford, Utica, Marcellus, and Haynesville). Despite the fact that production in the Eagle Ford was adversely impacted by weather and thus, drilling activity was below expectation in the quarter, management expects a higher rate of oilfield completion in 2014 as the company plans to perform drilling on 15 to 18 rigs in the year. In addition, management also anticipates higher production in 2014 driven by improved drilling efficiency and use of pad drilling.

The Utica project should see dramatic production growth and improved economics in 2014. Although the project was impacted by delays due to weather conditions in 2013, the project's midstream capabilities are expected to improve in 2014, and much of required capital spending has already occurred (e.g. the company has drilled more than 400 wells with only 200 producing now).

The stock currently trades at 5.4x forward 2015 EBITDA and 12.2x forward 2015 EPS (see charts below). Factoring in the company's consensus long-term earnings growth estimate of 20%, the shares trade at only 0.6x PEG, which is a very cheap valuation in my opinion.

Looking forward, I expect CHK's valuation multiple to expand from the current level as the company continues to monetize non-core assets and demonstrates operation progress in key areas. As EPS is estimated to rise significantly from $0.73 in 2013 to $2.11 in 2015 (based on consensus estimate), the price appreciation potential is likely to be substantial.

All charts are created by the author, and data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.

Disclosure: I am long CHK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.