Chesapeake: Get In Now For A Gas Price Recovery

| About: Chesapeake Energy (CHK)

Each week it seems that the spot price for natural gas moves to a new low and the current price is over 50% below where gas was selling for a year ago. The natural gas exploration and production companies have shifted to other markets - primarily natural gas liquids - and it seems like a bottom is forming for natural gas. The best company in which to invest for a gas price recovery may be Chesapeake Energy (NYSE:CHK).

The discovery and exploitation of shale gas plays in the continental U.S. has led to an explosion - pun intended - of gas production in the United States. Unfortunately, the large amount of supply coming on to the market plus a warmer-than-typical winter in 2011-2012 has pushed the price of gas down to levels two-thirds lower than the prices received as recently as 2009. As the largest producer of natural gas in the U.S., Chesapeake Energy has done more than its share to cause the current natural gas over supply / low price situation.

Many of the energy exploration companies have shifted most of their drilling away from dry natural gas and are now drilling for crude oil or the much higher value natural gas liquids. For example, EOG Resources (NYSE:EOG) has shifted from being one of the largest natural gas drillers and producers before 2006 to almost exclusive production of liquid energy products now. Chesapeake Energy has also shifted much of its efforts to finding and producing natural gas liquids, yet the company has maintained a position to profit handsomely from an increase in the price of dry natural gas. Here are some of the things Chesapeake has accomplished to position itself for a rebound in natural gas:

In 2011, the company reduced long-term debt by 18% and increased proven reserves by 10%, building assets for future production and reducing the current costs of debt financing.

Chesapeake is taking advantage of a yield-hungry investment community to turn assets into cash in the bank by selling assets to royalty partnerships and spinning of portions of the company into MLPs such as Chesapeake Midstream Partners (CHKM) and the recently registered IPO request for Chesapeake Oilfield Services to trade under the symbol COS. The company monetized $2.6 billion worth of assets in the 2012 first quarter with a goal of $11 to $14 billion in 2012.

Chesapeake continues to increase - slowly - natural gas production and the company now accounts for almost 10% of all the dry natural gas produced in the U.S., up from less than 4% in 2007.

Chesapeake has aggressively pushed and advocated for increased use of natural gas as a transportation fuel. The company has invested money is several projects to produce or distribute gas as fuel.

With these steps, Chesapeake Energy is well positioned to profit from an increase in the price of natural gas. The company's longer-term forecasts show cash flow and profits declining in 2012, then returning to an upward trend in 2013 and later years. However, the results could be very ugly for 2012. Using projections from a recent investor presentation, if gas remains near the current $2 per mmBtu, the company will earn 82 cents per share for the year. At $3 gas, the earnings increase to $1.44 and $4 gas produces $2.05 in net income per share. For comparison, Chesapeake earned $2.80 per share in 2011 and the Wall Street consensus earnings estimate for 2012 is $1.39 per share. Competitor Canadian natural gas producer Encana (NYSE:ECA) earned 54 cents per share in 2011 and the 2012 earnings consensus estimate is 74 cents per share. Going into 2013, the Wall Street crowd expects Encana's earnings to drop back to break even and the Chesapeake earnings to nearly double from the 2012 estimate. With these energy exploration companies, actual results are highly dependent on what actually happens with oil and gas prices.

The 2012 first-quarter results from Chesapeake show the effects of very low natural gas prices. The company reported adjusted net income of 18 cents per share, down from 75 cents earned in the first-quarter of 2011 and well below the consensus earnings estimate of 39 cents per share. During the quarter, Chesapeake Energy voluntarily reduced natural gas production in both an attempt to shore up market prices and to not have to sell the gas into the current low value market.

It is hard to imagine an energy world where crude oil can be at $100 per barrel and natural gas remains at $2 per mmBtu. The technology and capability is improving to convert natural gas to transportation fuels and that trend alone should push up gas prices. Also, natural gas in the rest of the world costs three to five times the current U.S. price level. The oversupply will soon find ways to be exported to regions with higher pricing. Chesapeake Energy is the best bet to invest in rising natural gas prices. Investors should have a three- to five-year time frame to realize that value.

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