Natural gas producer Chesapeake Energy (NYSE:CHK) has seen a remarkable drop in its fortunes in the last month. Chesapeake shares have lost almost 12% in past month, underperforming the S&P 500's 1% gain. But, the slowdown looks temporary and Chesapeake should be able to make a strong comeback due to a few simple reasons.
Chesapeake has made a number of positive moves to improve the business, and this can be clearly seen in its first quarter results. The company's top line grew 47.4% year-over-year to $5.04 billion in the quarter, exceeding analysts' revenue expectations of $4.52 billion. In addition, Chesapeake reported earnings of $0.59 a share, beating the consensus estimate of $0.48 a share handsomely. Its first quarter net income climbed to $425 million from $58 million a year earlier.
The company is enjoying several tailwinds, such as higher prices, cost cuts and production increases. In fact, during the first quarter, Chesapeake reported year-over-year adjusted net production growth of 11%, while adjusted EBITDA grew 34%.
Increase in production and better pricing to drive growth
Chesapeake has now increased its production growth guidance to 9% to 12% for the full year, up from the previous 8% to 10% on an adjusted basis. Its ability to deliver growth and capital efficiency illustrates the strength of its portfolio, with the industry slowly returning to the growth track. The company's revival, after troubled times under former CEO Aubrey McClendon, is being helped by higher natural gas prices.
According to Bloomberg:
"U.S. gas fetched an average price of $4.72 per million British thermal units during the first three months of this year, a 36 percent increase from a year earlier, according to data compiled by Bloomberg."
Going forward, the company should continue enjoying the tailwinds of higher natural gas pricing. As reported on Marketwatch:
"The U.S. Energy Information Administration raised its 2014 and 2015 forecasts for natural-gas and gasoline prices in a monthly report issued Tuesday. The government agency said it expects natural-gas prices to average $4.74 per million British thermal units this year, and $4.33 next year. It previously forecast a 2014 average of $4.44 and 2015 average of $4.11."
Clearly, the EIA has bumped up the natural gas pricing forecast quite significantly, and it won't be surprising if it continues to do the same in the future as natural gas demand is on the rise. In fact, according to the EIA, natural gas consumption is expected to grow from 25.6 trillion cubic feet ((Tcf)) in 2012 to 31.6 Tcf in 2040, driven by increased usage across a variety of sectors. Chesapeake is positioning itself to make the most of this expected growth in demand by increasing its production rate.
For example, the average daily production rate of Chesapeake in the Eagle Ford is currently 95,000 barrels of oil equivalent, which was approximately 8% above the daily average rate in the first quarter. The company plans to exit the year in the Eagle Ford at a substantially higher rate than what was seen in December 2013.
A solid profile will reap benefits
Additionally, Chesapeake has a very robust NGL growth profile, driven by the startup of its ATEX pipeline shipments in the Utica and Southern Marcellus ahead of forecast, along with stronger first quarter production from these areas. These factors have resulted in an increase in its 2014 adjusted production growth outlook.
Chesapeake is in a strong position to maximize its margins in this region through its valuable ownership of transportation on the ATEX pipeline. Also, Chesapeake is focused on evaluating opportunities to utilize third-party ethane volumes to fulfill capacity commitments.
The transportation on ATEX for Chesapeake is progressing well, given the rapidly growing regional production profile and the potential for BTU-related pipeline restrictions. It intends to use this asset strategically to maximize its margins and maintain ethane recovery flexibility.
Efficient use of capital
Chesapeake delayed some completion activity from the first quarter to the second quarter due to the severe weather experienced during the first quarter. It also improved capital efficiency through lower spending during the first quarter. The average capital cost per well was reduced significantly during the first quarter of 2014 in comparison to the average well cost in 2013.
Therefore, it's spending much less capital dollars year-over-year, but is still managing to achieve or exceed its production growth targets. Chesapeake has decided to use a part of the excess cash it generated during the quarter for purchasing a number of rigs and compressors, subject to long-term lease agreements with the intention to reduce future corporate obligations and complexity as part of its strategic initiative.
Moreover, Chesapeake is on the look out for opportunities to upgrade its portfolio to focus on assets that best fit its strategy of profitable growth from captured resources. The company's targeted asset dispositions is believed to be value-accretive, and allow it to further reduce financial complexity and lower overall leverage.
Chesapeake will continue to divest its non-core assets in order to improve the balance sheet. After spinning off its oilfield services business, it plans to divest ownership in its CHK Cleveland Tonkawa subsidiary. The company also plans to sell non-core assets in Oklahoma and Texas, for which it is expected to receive about $310 million.
Right moves and a solid valuation
So, Chesapeake appears to be on the right track. Its impressive financial results illustrate its sound strategies, financial discipline and profitable and efficient growth from captured resources. These moves are leading to improvements across the business.
In addition, Chesapeake's fundamentals are also quite strong. It has a trailing P/E of 21, and a forward P/E of 11, signifying robust earnings growth on the back of cost-cutting efforts and better production. Additionally, a PEG ratio of 0.75 indicates undervaluation. Finally, the company's earnings are expected to improve at a CAGR of 17.6% for the next five years. All in all, Chesapeake continues to remain a solid bet and it should continue improving on the back of its smart strategies and favorable industry trends.
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