Is Chesapeake A Good Buy On The Dip?

Aug.13.14 | About: Chesapeake Energy (CHK)

Summary

Chesapeake has been making interesting moves in its portfolio.

The company is well positioned to generate massive growth in production with its recent strategic initiatives.

Chesapeake is not a good buy.

Chesapeake Energy (NYSE:CHK) has been gaining momentum with its recent strategic moves. The company is looking to strengthen its financial flexibility and to generate growth from its existing asset portfolio at a lower cost. The company has been making changes in its assets portfolio so that it may do that. Recently, the company announced a spin-off of its oil field services business, repurchased outstanding shares of CHK Utica, L.L.C. (CHK Utica) and entered into an agreement with RKI to exchange its non-operated northern Powder River Basin acreage for RKI's southern PRB acreage. In addition, in the last quarter, Chesapeake has received $675 million from the sale of non-core assets and looks to receive $700 million in the second half of 2014.

The company has been planning to accelerate its production level. Thus, it has been increasing well connections. The company has used around 42% of its capital budget on increasing well connections and it has been anticipating an increase in this area in the second half of this year. Moreover, its increased stake in the Powder River Basin to approximately 79% will substantially increase its oil potential. This transaction will increase its oil mix as a percentage of the total production. The company plans to grow its oil and liquid production because it is offering better margins than gas. In the past quarter, the company has increased its crude oil production by 12%, natural gas liquids by a substantial 72% and gas production also increased by only 7%.

This represents that the company has been taking calculated steps and making disciplined investments in high growth, high margin areas. Overall, its total production in the past quarter stands at 695,000 barrels of oil equivalent per day, an increase of 30% on a year-over-year basis. In addition to that, Chesapeake has increased its production estimate by 10,000 barrels of oil equivalent per day. It anticipates exiting the year with a production of 730,000 barrels of oil equivalent per day. This is due to the increased well connections, the recent increased stake in Powder River Basin and the momentum it has been carrying.

However, due to lower margins and other items, the company was not able to convert higher production growth into big profits. In the latest quarter, it generated earnings per share of $0.36 which is well below the past year earnings of $0.66 per share. Nevertheless, in the recent quarter, the company has been successful in lowering average per unit production expenses by 5%. The company is further planning to lower its expenses to give a boost to its earnings. Meanwhile, Chesapeake remains successful in lowering capital investments by adopting a balanced capital allocation strategy. Its aim is to balance cash flow from operations with capital expenditures. Reports from the past quarter show that it has made progress in this strategy because its operating cash flows have expanded as compared to the past quarter. However, the company is still not fully covering its capital requirements.

In Conclusion

Chesapeake has set strong measures for future growth as evidenced by its strong production growth. With the recent spin-off of the oilfield services business, the management will focus more on its core business which will definitely have a positive impact in its performance. The repurchase of outstanding shares of CHK Utica will strengthen its balance sheet and acreage swap with RKI Exploration & Production, LLC (RKI). The company's focus on enlarging oil and liquid production also will enhance its margins going forward. Moreover, its strategy to maintain a balance between capital investment and cash flows while lowering operating costs will enhance its production performance. On the flip side, due to its high cost business model and excessive dependence on natural gas, I am expecting significant pressure on margins going forward.

Whereas, if we look at its industry peers including ConocoPhillips (NYSE:COP) and Anadarko Petroleum (NYSE:APC), both have moved their focus toward oil and liquid plays. Their percentage of total production from oil and liquid plays has been increasing and is enhancing their earnings and cash flows. In particular, COP is trading at attractive valuations compared with CHP and is generating better earnings and cash flow growth. COP is only trading at 12.5 times to earnings compared CHK's 36 times to earnings. ConocoPhillips also is offering an attractive entry point with the existing market correction. In addition, COP is offering a much higher dividend yield than Chesapeake.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.