Chesapeake Energy Is Finally Joining EOG Resources In Its Oil Success Story

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 |  About: Chesapeake Energy Corporation (CHK), Includes: EOG
by: David White

Summary

CHK and EOG both started as primarily natural gas companies.

EOG became a successful natural gas to liquids convert quickly. It now gets 88% of its revenues from liquids.

CHK was much slower to convert due to its huge debt problems. However, it has turned the corner on those; and it now gets 62% of its revenues from liquids.

Both stocks are good investments. But for the longer term investors have to like CHK's next 5 years' EPS growth per annum of 35.03% versus EOG's 6.63%.

CHK also has 10 -15 million net acres of great oil and gas development fields. EOG has only about 2 million net acres.

Chesapeake Energy (NYSE:CHK) and EOG Resources (NYSE:EOG) were originally both primarily natural gas E&P companies. When the bottom started to drop out of natural gas prices, both attempted to move more significantly into liquids E&P. EOG with a much lesser debt problem was able to succeed at this much more quickly. It has been a standout performer in the oil and gas E&P arena. EOG bought into several main oil development areas: the Eagle Ford Shale (about 632,000 net acres with 564,000 net acres in the crude oil window), the Bakken (about 90,000 net acres in the Bakken Core), the Delaware Basin (about 207,000 net acres) and the Midland Basin (about 113,00 net acres). EOG has since been developing these great oil plays along with its approximately 971,000 net acres of natural gas and combo fields (a small amount of the Eagle Ford acreage is mentioned twice above).

EOG went from 55.2 Mbo/d of production (of crude and condensate) at the end of FY2009 to 220.4 Mbo/d at the end of FY2013. That is roughly four-fold growth in oil and condensate production in just four years. This testifies to the quality of EOG's engineering and management teams.

At the same time EOG allowed its natural gas production to fall from 1,645 MMcf/d at the end of FY2009 to 1,347 Mmcf/d at the end of FY2013. The fact that natural gas prices fell dramatically during this period is just further testament to EOG management's astuteness. EOG also grew its NGLs production from 23,600 barrels per day at the end of 2009 to 65,200 barrels per day by the end of FY2013. Again it is a plus that EOG grew its oil production much faster than its NGLs production during this time. It is also a testament to the quality of EOG's assets.

It is not surprising that EOG's EPS have grown dramatically over that time. EOG's last five year EPS growth was 38.61% per annum, which is quite impressive. EOG's next five years' EPS growth forecast per annum is good at 6.63% per annum; but it is a lot less impressive. Still EOG is a great grower; and it will still be a good investment for many years to come. It has a drilling inventory of about 15 years. It is not close to the end of its development growth; and it is in a position to buy more oil and gas development leaseholds. In FY2013 it grew its Eagle Ford reserves alone by 45% from 2.2 Bboe to 3.2 Bboe (net to EOG). It increased the company's total net proved reserves by 19%. For FY2014 it plans to grow crude oil production by 27% and total production by 11.5%. EPS are forecast to grow by 22.10% in FY2014 and by 13.10% in FY2015. Total cash (mrq) was $1.32B; and total debt was $5.91B (mrq). These are very reasonable numbers when compared to EOG's market cap of $53.56B and enterprise value of $60.56B. With a PE of 24.39 as of the close April 28, 2014 and an FPE of 17.26, EOG is a good buy.

Chesapeake Energy has had to struggle through a much more dire debt situation. Former CEO Aubrey McClendon had "bet the farm" on natural gas just before natural gas prices plunged for the first time. This left CHK with a huge debt load. Aubrey McClendon got around this problem by grabbing huge leaseholds very early on in new unconventional oil and NGLs development fields. CHK would then do a modicum of work in the field to prove the acreage partially. Then CHK would sell 25% to 33% of that acreage for a much higher price to a JV partner or just to an outside buyer for usually more than the cost of all of the original leaseholds and the work CHK had done on the leaseholds to that date. This gave CHK the money to fund its development program; and it effectively allowed CHK to acquire great unconventional oil and NGLs fields for free. In effect CHK was able to survive on skill and wit.

CHK is still in worse debt trouble than EOG. However, its debt situation has improved over the last few years. CHK has $837 million in cash and $13.02B in debt. The market cap is $18.92B; and the enterprise value is $31.88B. However, CHK is now controlling its costs. It had total adjusted net income of $1,146 million ($1.50 per common share) in FY2013 versus $456 million ($0.61 per common share) in FY2012. Operating cash flow was $4,956 million for FY2013. This was up substantially from $3,920 million in FY2012. In addition CHK has been decreasing its expenses as it has been increasing its profitability. The CapEx for FY2014 is forecast to be $5.4B versus CapEx for FY2013 of $6.7B. The FY2013 figure was down even more drastically from the $13.4B in FY2012. Part of the savings has been the use of pad drilling. This saves the cost of a rig having to be disassembled; moved; then reassembled. Modern rigs can just be "walked" to the next site on a pad. Some put the cost savings of this at approximately $1 million of the total drilling costs. For FY2014 CHK plans to do 97% pad drilling. In FY2013 that figure was just 59%; and in FY2012 it was only 35%.

CHK had $4.4B in asset sales in 2013. CHK's management has indicated that cash flow should cover its CapEx this year. However, it is still talking about further asset sales. Recently CHK announced the execution of two agreements to sell midstream compression assets for total proceeds of $520 million to Exterran Partners (EXLP) and Access Midstream Partners (NYSE:ACMP). These transactions are expected to close before the end of Q2 2014.

In March 2014 CHK announced that Chesapeake Oilfield Operating LLC (COO), a wholly owned subsidiary, has filed a Registration Statement on Form 10 with the US Securities and Exchange Commission. COO conducts the operations of Chesapeake's oilfield service division, Chesapeake Oilfield Services (COS). Essentially this is a filing for a possible later spin-off of the subsidiary. This spin-off is expected to be US federal tax-free to shareholders. Some have suggested that this may be worth about $2.5B as a spin-off. This likely extra $3B may help CHK pay down its debt; and I am sure these are not the only deals that CHK will do in FY2014.

CHK is also working on improving its debt structure. It recently announced a $3.0B senior notes offering. These notes were issued in two separate series of notes. The first was $1.5B in Floating Rate Senior Notes due in 2019. These were at LIBOR plus 3.25%, which will reset quarterly. The second was $1.5B in 4.875% Senior Notes due in 2022. The offerings closed on April 24, 2014. Part of these monies will be (or have been) spent on retiring all of CHK's 9.50% Senior Notes due in 2015. There are $1,264,697,000 of these. The early tender results are $945,908,000 worth of the notes. The tender offer is set to expire on May 7, 2014 at 11:59 pm New York City time. It would appear that CHK is lowering the rates it will pay on its debts. This is just another sign of CHK's good management; and it should pay off in increased profitability for CHK in the future.

So far it may seem that EOG has beaten CHK in almost every way. It is even planning to grow its overall production by 11.5% in FY2014 versus CHK's planned production growth of 2% - 4%. However, EOG has not been selling assets in the way CHK has. CHK is actually planning to grow adjusted (for the sales) production by 8% - 10% in FY2014. This is very close to EOG's growth figure.

Based on EPS growth CHK wins by a landslide. Analysts forecast a next five years EPS growth per annum of 35.03% versus EOG's 6.63%. This makes a lot of sense when you realize CHK is slowly getting its finances under control. It also makes a lot of sense when CHK has 10 - 15 million net acres of great unconventional development plays, while EOG has only about 2 million net acres (including its natural gas fields). I don't know the exact number for CHK because the 2013 annual report is not out on the CHK website yet. However, the number is sure to be in the cited range; and that is still at least five times more good development acreage than EOG has. CHK should be able to keep growing quickly for a very long time. Supporting this, CHK's PE is 40.06; and its FPE is 12.64, which is a huge improvement. Further CHK's assets should become more valuable over time; and there are a lot more of them.

In addition to the above, both EOG and CHK should benefit from likely rising natural gas prices. A recent article, 8% To 10% Dividend Payers Breitburn And Vanguard Will Benefit From Increasing NatGas Prices, reviews some of the reasons to expect US natural gas prices to rise over the next several years. CHK is the #2 producer of natural gas in the US. It is expecting to produce approximately 1090 Bcf of natural gas in FY2014. An additional $1/mmbtu increase in the US price of natural gas (per Mcf) would mean an extra $1.09B in revenues. Of course, CHK has hedges, so it is currently only expecting to realize $4.16/mcf in FY2014.

However, higher natural gas prices will translate into higher hedges and higher profits over time. Plus they will translate into immediately increased profits for the natural gas that is not hedged in 2014. For EOG the same is true, except that it will produce only about 500 Bcf of natural gas in FY2014.

Natural gas may lead both of these companies to exceed their FY2014 revenue and EPS targets. Both are buys; but I do like CHK better on its much better long term growth forecast and its much greater amount of development acreage. It has turned the corner to responsible management; and it is unlikely to turn back. It should give investors many years of great growth. Of course, some will point out that EOG's production revenue mix is expected to be 88% from liquids (mostly from oil) in FY2014, while CHK's production is only expected to be 62% from liquids. They will also point out that EOG has oilier oil assets. However, CHK's assets are oily enough; and it has a lot more of them. Plus CHK should benefit greatly as the price of US natural gas rises over time.

The two year chart of CHK provides some technical direction for this trade.

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The slow stochastic sub chart shows that CHK is overbought currently. The main chart shows that it is in a weak uptrend. Given the problems most oil and gas E&P companies had due to the unseasonably cold winter this year, it is probably a good idea to wait until after CHK reports Q1 2014 earnings to buy the stock. However, CHK does appear to be a stock investors will want to own for the long term. One strategy for getting in may be to average in over the course of 2014. If there is a significant overall market fall as many are predicting, the averaging in strategy should protect investors. The quality of the stock should protect investors longer term.

The two year chart of EOG provides some technical direction for this trade.

Click to enlarge

The slow stochastic sub chart for EOG shows that EOG is neither overbought nor oversold. The main chart shows that EOG is in a relatively strong uptrend. However, EOG could easily retrace a significant amount without violating its uptrend. Plus we don't know how much EOG's profits got hurt by the colder than normal winter. It is again probably a good idea to wait until after EOG's earnings report to buy the stock. Again it appears to be a stock investors may want to hold for the longer term. It has a 15 year inventory of drilling sites; and it has the fiscal soundness to be able to buy more.

CAPS gives EOG a five star rating (a strong buy); and it gives CHK a four star rating (a buy). The mean analyst recommendation for EOG is 1.9 (a buy). For CHK the mean analyst recommendation is 2.8 (a high hold). However, I believe too much of the negative analysts' sentiment about CHK stems from analysts bad experiences with CHK from the Aubrey McClendon days. CHK appears to now be a solid, quickly growing company; and I think the analysts' rating is out of wack with reality (possibly the result of sour grapes). CAPS usually moves before analysts do; and I find the CAPS rating much more realistic. With activist investors such as Carl Icahn heavily involved in CHK, this should be even more true. CHK is a buy.

NOTE: Some of the above fundamental financial information is from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CHK, EOG over the next 72 hours. 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.