Chesapeake Energy - Continued Progress Reveals The Long-Term Potential

| About: Chesapeake Energy (CHK)


Chesapeake reported strong production growth in first quarter, hikes its full year production forecast.

Operational cash flows are set to surpass capital expenditures this year.

Leverage reduction and production growth reveals long term potential for shares.

Investors in Chesapeake Energy (NYSE:CHK) continue to be pleased with the troubled natural gas and oil producer's progress to reduce leverage and grow the business in a controlled manner.

Strong production and earnings, lower capital expenditures and asset sales have improved the cash flow picture dramatically in Chesapeake's quest to reduce debt. I continue to be a buyer on the dips.

First Quarter Headlines

Chesapeake Energy reported strong growth for the first quarter with revenues increasing by 47.4% to $5.05 billion. The strong topline growth resulted in strong earnings growth with GAAP earnings increasing from just $15 million last year to $374 million over the past quarter.

Adjusted earnings rose from $0.30 to $0.59 per share, coming in at $405 million.

Strong Operating Performance

Chesapeake reported production of 675,200 barrels of oil-equivalent per day, up 11% after adjusting for divestments. The strong production in the first quarter prompted the company to increase its full year adjusted production outlook from 8-10% growth to 9-12%.

The shift towards oil and NGL production as well as high natural gas prices during the harsh winter, combined with strict cost control for general & administrative costs, were the big drivers behind earnings growth. To illustrate, realized natural gas prices rose by 72% to $3.27 per thousand cubic feet. Note that while Chesapeake focuses more on oil and less on gas, the latter energy source still makes up the vast majority of production.

Oil production came in at 109,500 barrels, NGL production totaled 84,200 barrels while the remainder of production was natural gas. Adjusting for sales it was NGL production, which rose by 63%, oil production increased by 20% and the natural gas production rose 4%.

Capital Expenditure Cut

While production continues to grow on the back of past investments, Chesapeake is actually cutting back on current capital investments. Its investment budget was cut in half to $850 million in the first quarter.

As a matter of fact, the company aims to increase activity levels of capital expenditures compared to the first quarter. Despite increased investments throughout the year, investments will still come in below the levels of last year. Annual capital expenditures are now seen between $5.2 and $5.6 billion.

At the midpoint of this range, capital expenditures will trail expected operating cash flows for the first time in a long time. To illustrate the degree to which expenditures have been cut back, in 2011, Chesapeake's CAPEX budget was $13.4 billion.

As a matter of fact, an incredible 80% of these investments are targeted towards liquids production, at a time when natural gas production still makes up roughly three quarters of total production.

Assets Sales

Despite the growing production and earnings, Chesapeake continues to focus on asset sales to reduce debt and contain the leverage position.

During the quarter, proceeds of $520 million were recorded from asset sales related to equity ownership in Chaparral Energy, the sale of units to Access Midstream Partners L.P. (NYSE:ACMP) as well as in real estate. Chesapeake furthermore stressed that it received $362 million in proceeds in the month of April with more details being announced regarding its disposition strategy on the analyst day on May 16.

Separately, Chesapeake continues to seek out the strategic alternatives for its oilfield service business. A spin-off or an outright sale are being considered at the moment.

An Improved Cash Flow Picture

The combination of growing and profitable production, a big reduction in capital expenditures and divestments boost the operating cash flows available for the firm. Full year operating cash flows are now seen between $5.8 and $6.0 billion, some $700 million more than previously anticipated.

Despite these encouraging developments, total cash stands at just little above a billion as the net debt position of $12.0 billion is essentially unchanged compared to last year. Yet the combination of growing earnings, production, lower capital expenditures and actually growing operations means that relative leverage is coming down rather quickly.

Investors Approve Lawler

Investors are undoubtedly happy with CEO Lawler's performance. Doug Lawler was appointed nearly a year ago as the chief executive and shares have risen nearly 50% over the past year, approaching the $30 barrier.

Under his tenure, the company has increasingly focused on liquids production and asset sales, although these trends were already started by the former CEO, Aubrey McClendon. McClendon was forced out after overspending in the years ahead, thereby saddling Chesapeake with debt.

Implications For Investors

In hindsight the hiring of Lawler and the cold past winter have been the turning point for Chesapeake. Adjusting earnings should quite easily come in above $1 billion and, depending on the weather, could approach a run rate of $1-$2 billion going forwards. This is as production continues to increase in all likelihood.

At $29 per share equity in the energy producer commands a roughly $19 billion valuation. This values the company at 12-13 times earnings assuming $1.5 billion in earnings going forward, which seems very reasonable. Of course, the debt overhang remains, yet progress is being made on a continuous basis and liquidity and solvency fears are off the table, at least in the short term.

With major trends moving in the favorable direction, Chesapeake has passed its turning around point. I continue to be a buyer on decent dips.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.