Chesapeake Energy: A Long-Term Play On Natural Gas As An Automotive Fuel

| About: Chesapeake Energy (CHK)

With the price of oil rising, and the cost of natural gas falling, it only seems logical that the country should start placing a larger focus on natural gas as a vehicle fuel source. I personally feel that it's only a matter of time before we do see a massive conversion to natural gas - one that mimics something of a revolution.

However a week ago a news release came across the wires that had me thinking this so called "revolution" may be here sooner rather than later. Just last week it was announced that General Electric (NYSE:GE) and Chesapeake Energy Corp. (NYSE:CHK) will be working together creating a new infrastructure of natural gas fueling stations. The move comes as more U.S automakers are beginning to design new natural gas powered cars and trucks in order to meet the demands of many consumers who are fretting high gasoline prices. As the looming threat of $5 a gallon gasoline has many drivers worried, more drivers are looking to fill their vehicles with the more low cost, and abundant fuel source of natural gas. The only problem is that there's only a limited amount of refueling stations in the U.S that support the gasoline-substitute. The infrastructure that is needed to support a massive shift from gasoline to natural gas in the U.S just simply isn't there as currently there are less than 400 public compressed natural gas "CNG" refueling stations in the United States - something G.E and Chesapeake aim to change.

The two companies have collaborated to address this problem and plan to add an additional 250 natural gas fueling stations through 2015. The refueling system created by GE, known as the "CNG in a Box" will be marketed by Peake Energy solutions (an affiliate of Chesapeake Energy). The "CNG in a Box" system works by taking natural gas from a pipeline and compressing it on-site, thus creating compressed natural gas or CNG, at an industrial location or traditional refueling station. A driver using a CNG vehicle simply dispenses the natural gas just the same as an ordinary gasoline or diesel dispenser. With the infrastructure wheels in motion, it seems the only remaining concern is whether people will buy into the idea of driving a vehicle that runs on natural gas rather than gasoline. However I have a pair of statistics that I think could easily win people over:

· A vehicle using CNG can reduce its fuel costs by up to 40%, assuming gasoline priced at $3.50/gallon and CNG at $2.09/gasoline gallon equivalent.

· Using Liquid Natural Gas (LNG) can reduce engine combustion emissions by almost 25%.

The Future Is Now

Chesapeake Energy is definitely setting itself up to benefit greatly from a large scale conversion to natural gas as a commercial fuel source in the future. However the company is also already positioned to benefit from the current increase in demand for natural gas by the trucking industry. The trucking industry is currently the only real sector of highway transportation in the U.S that is currently shifting to natural gas.

To help benefit from this shift Chesapeake has formed key partnership and strategic investments. In February Chesapeake announced that they were collaborating with 3M to design a more cost effective CNG tank to be used in all transportation sectors. The fuel tank on a CNG vehicle is the most expensive component of the vehicle, so by making a more cost effective tank, Chesapeake and 3M are hoping to make the switch to natural gas more attractive. Also in 2011, Chesapeake invested $150 Million in Clean Energy Fuels Corp (NASDAQ:CLNE), the nation's largest provider of natural gas for transportation purposes. The investment will help fund the construction of approximately 150 natural gas truck refueling stations along major trucking corridors in the United States.

Chesapeake's Fundamentals

While there looks to be a promising outlook for natural gas as future gasoline substitute, there is also a very positive outlook more specifically for Chesapeake Energy. Chesapeake has addressed many of its concerns over the past few years and plans on continuing to sure up its operations. One of the company's previous concerns was the high amount of debt they held on their balance sheet, but over the past year the company has reduced their debt by 18%, and plan on reaching their 25% debt-reduction goal during FY'12. They have also addressed their high natural gas exposure over the previous few years. The company, which previously operated almost 90% in the natural gas space, has been aggressively shifting their focus to a more balanced approach. For example In 2011 alone, CHK grew their liquids production by 70%, and plans on having their liquids production account for 30% of total production and 55% of total revenues by 2013.

Finally the company plans to address some of their liquidity concerns this year as well. Since the increased emphasis on liquid production comes with a cost, the company plans on financing this expansion by selling off some of their natural gas plays. Chesapeake expects total cash proceeds of $10-$12 Billion over the next year from varying natural gas related asset sales.

Share Price Valuation

Shares of Chesapeake energy are trading at a fairly inexpensive valuation. Their shares are trading at just eleven times current earnings and at a discount to the broader market- the P/E Ratio of the S&P 500 is currently around 15. Using the P/E ratio we could see that CHK is undervalued, but the P/E ratio only shows how the stock is trading in relation to its current earnings. To compensate for this we use the PEG ratio or simply the companies P/E over growth rate. Chesapeake Energy has a PEG ratio of 1.19 which shows that the company is trading fairly inexpensive to its future earnings as well. Another key indicator pointing towards Chesapeake's relatively inexpensive valuation is its price to book value ratio of nearly 1, meaning the shares are almost trading at exactly their underlying book value.

Overall Chesapeake Energy looks to be a solid long term play on the growing demand for natural gas as a fuel source. The company has made a large commitment to making natural gas - liquid and compressed natural gas to be exact - as a commercial fuel source. They have made many investments and have been working on numerous collaborations which have positioned them at the forefront of this transition. This coupled with the company's improved financial position, and relatively inexpensive valuation makes them a very attractive stock at this price level. Though a continuing decline in natural gas prices may still have a negative impact on Chesapeake Energy in the short- term, in the long run I think this company is in the best position to benefit from a continuing shift towards natural gas as a transportation fuel.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.