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Summary

  • Chesapeake missed estimates by the biggest margin in two years when it last reported results.
  • But Chesapeake is doing the right thing by selling off non-core assets and reducing its debt as this will drive long-term profitability.
  • Chesapeake expects pricing trends in the industry to get better, and the EIA concurs on this point, and this will lead to better results going forward.

Shares of natural gas company Chesapeake Energy (NYSE:CHK) are down 3% this year after a solid run up in 2013. One of the primary reasons contributing to this sluggish performance this year is Chesapeake's weak fourth-quarter results that were released in late February.

Chesapeake Energy missed analyst's estimates by the biggest margin in two years last quarter. The weak performance was mainly on account of one-time charges that Chesapeake had to face due to employee termination costs and discontinued rig lease contracts.

The weather was also against the natural gas producer. Its production was negatively affected by more than 6,000 barrels of oil lost per day due to heavy rains, flooding, and freeze-offs during the fourth quarter in the Mid-Continent and South Texas areas. It also incurred an additional loss of production at Utica due to the loss of the Natrium gas processing facility for the entire quarter.

Still doing relatively well

But, despite these challenges, Chesapeake's production was above the midpoint of its 2013 guidance. Also, Chesapeake has made good progress through spin-offs and asset sales. Keeping such developments in mind, can Chesapeake come out of its slump?

All was not bad regarding Chesapeake's fourth quarter. Its revenue rose 28% to $4.54 billion, although it incurred a net loss of $159 million compared to a profit of $250 million last year. But, excluding the one-time charges, it had a profit of $161 million. Considering Chesapeake's efforts to reduce its debt (which stands at a huge $13 billion) by selling off non-core assets, I think that the company could improve in the future.

Reducing the burden

Chesapeake has terminated various employees as a part of its restructuring strategy. The company is taking such initiatives to increase its competitiveness and build a solid financial foundation that will enable it to be successful through the commodity price cycle.

Continuing with its restructuring strategy, Chesapeake has sold some of its assets. It has sold its interest in Chaparral Energy, along with various other non-E&P assets. The total amount emerging from this sale is around $1 billion. According to CEO Robert Lawler, "These asset sales are expected to have minimal impact on our current 2014 operating cash flow guidance."

Chesapeake has also announced the sale of 437 natural gas compression units and related assets in two separate deals to Access Midstream and Exterran for $520 million. The natural gas producer is selling its assets to cover the $1 billion gap between operating cash flow and capital expenditure. It also plans to cut expenditure by 20%.

Chesapeake Energy will also spin off its oil field services division. In each of its two businesses - exploration and production and oilfield services - to better leverage opportunities and appeal to a wider combined investor base.

Conditions to get better

Looking forward, Chesapeake expects gas price differentials to contract significantly due to very strong pricing in the Northeast. To protect itself from fluctuating prices in the future, it has hedged itself for the second, third, and fourth quarters of 2014 and entered into more material volume hedges covering the first quarter of 2015. It has also entered into hedges covering a significant percentage of its Northeast gas volumes

Chesapeake is aggressively focused on decreasing its costs and various other unwanted charges through various measures stated above. Consequently, it has improved its cash position and net working capital deficit, net long-term debt, and other long-term liability positions by $922 million in aggregate. It has also repurchased certain drilling rigs and compressors subject to sale-leaseback transactions, which will reduce leverage and facilitate the oilfield services spin-off.

Natural gas price forecast

The benefit of these moves can be expected when natural gas prices get better. According to the EIA, natural gas prices are expected to average $4.44 per million British thermal units this year and $4.14 in 2015. This is better than the previous estimates of $4.17 and $4.11, respectively. Hence, Chesapeake is doing the right thing by strengthening its balance sheet, and given the company's dominating position in the natural gas industry in the U.S., its performance should improve as prices get better.

Conclusion

Currently Chesapeake has a trailing P/E of 36, a promising forward P/E of 12 indicates that earnings growth can be expected going forward. The company is making some decisive moves to make its operations more efficient. This is important and could reap rich rewards for Chesapeake when natural gas prices rise, enabling the company to come out of its slump.

Source: Is Chesapeake Making The Right Moves To Come Out Of Its Slump?