Back on the Radar: Chesapeake Energy

Includes: CHK, MCF
by: The Manual of Ideas

Chesapeake Energy (NYSE:CHK) has for some time been synonymous with the vast untapped opportunity in U.S. onshore natural gas shale plays. As gas prices have remained depressed relative to oil prices longer than most expected, it appears many investors have slowly but surely given up on the company.

While the near-term outlook for natural gas remains unfavorable, the underlying value of Chesapeake’s assets and the lagging stock price have once again attracted considerable superinvestor interest. Famed oil and gas investor Boone Pickens more than doubled his fund’s stake in Chesapeake during the second quarter. Carl Icahn’s firm boosted its position from two million to nearly 13 million shares, while Mason Hawkins’s Southeastern Asset Management slightly added to its stake, which amounts to a considerable 12% of Chesapeake. Only David Winters’s mutual fund went against the grain, selling out of a relatively small position.

Our analysis of Chesapeake suggests that the value of proved reserves alone may be sufficient to justify the recent stock price, based on NYMEX strip pricing. When one considers
the fact that the company’s unproved reserves amount to roughly 15 times proved reserves, the upside in Chesapeake becomes clear.

It’s worth noting that the company is run by one of the most highly regarded executives in the business — Aubrey McClendon — and that Chesapeake can credibly claim to be one of the natural gas industry’s low-cost producers (Contango (NYSEMKT:MCF) is another). McClendon, who has shown shrewdness in timing the company’s purchases and sales of natural gas price hedges, has recently begun emphasizing crude oil reserves as a part of Chesapeake’s mix. This move appears to have been interpreted negatively by the market — after all, if the industry’s leader is perceived as moving away from natural gas, then what does this mean for the future of gas? However, we interpret McClendon’s moves simply as another way of safeguarding shareholder value, regardless of whether or not the relationship between oil and gas prices returns to its historical norm. After all, while McClendon may be better than most at predicting natural gas price, no one knows what the price of natural gas will be in five years.

This truism lies at the crux of the investment thesis for Chesapeake: If natural gas prices remain depressed, Chesapeake will likely preserve equity value (net income is projected at ~$3 per share in each of the next couple of years). However, if gas prices rise to the high single digits, shareholders may reap multiples of their investment.

Disclosure: No positions