Chesapeake Energy: Strong Gains Ahead

| About: Chesapeake Energy (CHK)

Oil and gas companies are great investments in a down or volatile economy. They shine as hedges against declines in the value of the U.S. dollar, which makes them a perfect addition to any portfolio. After all, so many companies are based in the U.S., operate in the U.S., have suppliers in the U.S. or are otherwise are affected by the U.S. economy that having a hedge against declines in the U.S. dollar is a good thing, and investors could do a lot worse than oil and gas stocks. Companies in this industry tend to offer modest but consistent dividends and strong share price performance.

Take Chesapeake Energy (CHK) for instance. It has raised its dividends consistently since 2002. Today, the stock trades for roughly $22 a share and pays a 35 cent dividend (1.60% yield). The company, is a top 15 producer of oil and natural gas liquids, may seem to be on the wrong side of things right now - natural gas prices are low and reserves high - but looking at Chesapeake Energy from a longer term viewpoint and the depressed price is actually an opportunity. Natural gas is a commodity. It will go back up. Further, as the population increases so will demand - be it for personal use or for industries. Buying into a company like Chesapeake Energy now, while the price is low, will make sure you are well-positioned when the price does rebound.

Chesapeake Energy is in a bit of cash crunch right now because natural gas prices are at their lowest in the past 10 years, but the company is being proactive about it. In January, Chesapeake Energy outlined a plan to continue creating shareholder value in spite of the low gas prices. The company is reducing its operated dry gas drilling activity by 50%, cut back its current operated gross gas production by 8% and reduce its underdeveloped lease expenditures. Then, with the money saved, Chesapeake Energy plans to reallocate its capital savings from to more liquids-rich plays that offer superior returns in the current strong liquids price environment. In other words, Chesapeake Energy is planning on chasing the money in high crude prices while trimming the fat in its operations.

Chesapeake Energy also has made a series of strategic alliances that are bound to better its position. In February, the company announced an agreement with 3M (MMM) to design, manufacture and market tanks to transport Compressed Natural Gas (CNG). Then, in March, the company announced a collaboration with General Electric (GE) to speed the adoption of natural gas as a transportation fuel. Together, they have plans to deploy more than 250 fueling systems across the US by the end of 2015. These systems are CNG fueling stations for Natural Gas Vehicles (NGV). The pair is to begin rolling the stations out in fall this year.

Chesapeake Energy is priced low relative to its peers. It is currently priced at 7.51 times its forward earnings, compared to 11.56 for its peers. The company is also priced at a discount with regards to its book value. It has a price to book ratio of just 0.92 versus its industry's average of 5.74. Chesapeake Energy is priced low compared to its peers relative to sales (1.32 vs 1.71) and cash flow (2.59 vs 9.35) as well.

Chesapeake Energy enjoys high revenue growth of 38.1%, compared to its industry's average of 26.0%. The company has been relatively successful in managing its debt. Its debt to equity ratio is just 0.65, which is less than its peers' average. Chesapeake Energy also enjoys a strong increase in earnings per share, going from 28 cents a share in the fourth quarter 2010 to 63 cents a share in the fourth quarter 2011

That's not to say all is not perfect with the company. Chesapeake Energy's quick ratio is a quite low at 0.41, suggesting that covering short term obligations could be problematic. The company's shrinking return on equity is also something of a concern. It fell from 10.89% at the end of the fourth quarter 2010 to 9.44% at the end of the fourth quarter 2011. But, I think that the company's low valuation, solid management and strong strategic prospects more than outweigh these issues.

Chesapeake Energy competitor Exxon Mobil (XOM) recently traded at just under $85 a share with a $1.88 dividend (2.20% yield). The company is priced higher than Chesapeake Energy, at 9.51 times its earnings and 2.61 times its book value. Its earnings per share has decreased the last three quarters, but its performance quarter over quarter is solid. The company's EPS was $1.97 at the end of the fourth quarter 2011, up from $1.85 at the end of the fourth quarter 2010. Exxon's debt to equity is lower than Chesapeake Energy, at 0.11, and its quick ratio, while still low, is higher than that of Chesapeake Energy, at 0.67. Obviously, Exxon is a great stock - its track record alone is enough to warrant investment - but I think that investors looking for a larger upside, that are willing to take on some risk, should choose Chesapeake Energy instead.

Rival Anadarko Petroleum (APC) recently traded at $78 a share and pays a 36 cent dividend (0.50% yield). The company is priced higher than its peers at 15.41 times its forward earnings, but its price to book value is lower than its industry's average, at 2.15. Anadarko's debt to equity ratio is higher than its peers, at 0.84, but its quick ratio is strong, at 1.22. The company's earnings per share is, however, disappointing. It had an EPS of -$5.33 at the end of 2011 versus $1.52 at the end of 2010.

Analysts are expecting Anadarko's EPS to increase to $3.79 this year, but there are no guarantees. Some analysts are extremely bullish on this stock, such as Global Hunter Securities and Stifel Nicolaus, but I am not convinced. I would need to see a little more from this stock before could recommend it as a buy. The company's stock performance was flat in the first quarter this year, which is not something I find encouraging given the enthusiasm over its prospects. I recommend Chesapeake Energy instead. Again, it has a good mixture of low valuation, strong prospects and solid management.

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