Assessing Chesapeake's March 15 Notes: The Yield Reflects The Risk

| About: Chesapeake Energy (CHK)

Summary

Chesapeake stock has been battered recently and now its March 15 bonds are yielding 31%.

Breaking down short-term balance sheet reveals that CHK is in a dicey financial situation.

Operating metrics are very difficult to estimate and earnings release is a full two weeks away.

The yield on the March 15 bonds is reflective of the very uncertain situation going forward; creditors aren't getting much value.

Worth considering risk-reward proposition from stock vs. these bonds.

A lot of attention has been paid to the tumultuous fall of Chesapeake Energy's (NYSE:CHK) common stock over the past year and especially in the past few weeks as the company's solvency has been called into question. The panic that drove last and this week's sell off has exacerbated CHK's downward move, with its shares now trading under $2.

March 2016 Notes

Little has been made of the Chesapeake notes that come due on March 15th of this year and now carry a YTM of 31.02%. There are a few major positives to this batch of bonds; first, they offer (potential) returns that would far outperform this stock market, and second, the maturity date is only a short month away. The drawback to these bonds is that CHK must stay afloat for that month and come up with $476 million to pay them for creditors to realize the full return. This article will be dedicated to determining Chesapeake's ability to pay off its March 2016 notes.

What They Can Use to Pay the Notes

There are three ways that Chesapeake can put together the cash to pay off its March 2016 notes; first- existing cash stores shown on the balance sheet, second- liquidating non-core assets, third- borrowing off untapped balance of existing credit facilities.

As of the last measurement at the end of September 2015, more than three months ago, CHK had $1.8 billion of cash and equivalents on its balance sheet. That number has been dwindling over the past few quarters and represents a 50% decline since the end of 2014. On the liabilities side, as of the end of September 2015, CHK had $1 billion in accounts payable, $2.5 billion in accrued and other liabilities, and $417 million in short-term debt not including the $476 million due on March 15, 2016. While it's a bit worrying that CHK's cash could not cover accounts payable and short-term debt obligations, perhaps it's quite troubling to consider that the company's cash stores are now most certainly lower than they were in September of last year giving the company even less power to cover its short-term liabilities.

Chesapeake company management has, like many of its peers, been playing up its plans to divest non-core assets. With upwards of $73 billion in PP&E the company has no shortage of assets to divest, but surprisingly lax in doing so last year as it liquidate only ~$250 million worth. It would be promising to see a bit more urgency to these efforts as CHK has been cash flow negative for the past six quarters.

Chesapeake's access to a $4 billion revolving credit facility could prove vital to its survival. As of September 30 of last year, the company had not used any of the facility's capacity. Specific terms of the contract may prohibit CHK from simply borrowing $467 million to directly pay off the March 15 notes, however, the credit line could help to ease the burden of accounts payable and other short-term liabilities allowing the company to pay the debts more easily.

What's Working Against CHK's Creditors

Predictably, Chesapeake is suffering from massive operating outflows as a result of lower commodity prices. Reporting a loss of nearly $5 billion before interest, taxes, and D&A last quarter, operating revenues surely won't help CHK deliver on the March 15 notes. The real question is how quickly will current operating metrics deteriorate the company, and for the best insight, investors will have to wait for the Q4 earnings announcement, which is a full two weeks away. A look to the commodities landscape offers a pretty bleak outlook for CHK although most of that has been factored into the price of the stock, as well as the debt by now. These next few days and weeks will determine a lot of whether or not CHK make it through March 15th.

Conclusion

CHK's March 15 notes present fantastic opportunity to achieve outsized returns in an otherwise choppy market. The notes' 30% YTM reflects the very real possibility that the company could default within the next month or so, and unfortunately in this case there is no clear evidence to support that Chesapeake will either continue chugging along and pay back the notes due March 15th or default before that date. To make matters more uncertain, investors will have to wait until February 24th for the earnings announcement, which will be the only accurate measurement of the company's solvency. From the available information, only investors with high tolerance for risk and a potential bankruptcy settlement should touch these bonds.

Disclosure: I/we 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.