Chesapeake Energy (CHK), the nation's second largest natural gas company, is embroiled in a soap opera-like management crisis at a time when management's focus needs to be on maintaining profitability in light of historically low natural gas prices. I thought it time to take a closer look -- not so much at the soap opera, but more at the fundamentals -- to see why the company's stock is trading at its 52-week low and what its future prospects are likely to be.
Chesapeake's stock touched $74 per share as recently as mid-2008, at a time when natural gas prices on the NYMEX were generally between $8 and $9 per mmBTU. Of course, natural gas is struggling to stay over $2 per mmBTU. There are a variety of factors at work that have both increased supply of natural gas and decreased demand for it. Supplies have been increased because natural gas is plentiful in this country, is environmentally more acceptable than oil or coal, and the proliferation of new hydraulic fracturing has made natural gas supplies easier to extract. Suppliers have found the going so easy that America's ability to warehouse additional quantities of natural gas is very limited.
Demand for natural gas, as T. Boone Pickens has said, is off due to a lack of an American energy plan. Natural gas is an excellent transportation fuel, yet we have virtually no transportation platform that uses it. Factor in a very mild winter throughout much of the country this year and demand for natural gas is well below its peak. Imbalance brings on strange prices, and natural gas supplies and demand are as imbalanced as it can get.
In light of these ultra-low gas prices, there is no way that a company like Chesapeake can have robust earnings. Adjusted earnings came in at $94 million, or $0.18 per share. This was a 76% decline from the year-ago quarter, and a full 36% below the lowered expectations analysts still had left for Chesapeake. The company had earlier committed to limit dry gas drilling in favor of liquefied energy sources. But Chesapeake's production of those liquid sources such as oil or liquefied gas came in well under expectations. Meanwhile, the company's overall production rose by 2%, so all the huffing and puffing about cutting back dry gas production was just that -- huffing and puffing.
Wildcard CEO Aubrey McCLendon may have been acting on inside information as he managed his second job as a hedge fund manager from his executive office at Chesapeake. That will be for the Chesapeake board of directors, lawyers, and the SEC to sort out. Chesapeake needs all the management expertise it can get to navigate through these times, and it clearly is a weakened energy company. Yet, from its current price point -- and if either supply and demand or some federal policy pushes natural gas prices up to respectable levels -- this might be a great time to get into this company on the cheap. Don't expect a quick buck, but a patient investor might double or even triple their money out to mid-decade.
For the here and now, let's look to Devon Energy (DVN). While the company's stock price is down about 18 points, or 21%, from its 52 week high set back in May of last year, its earnings are marching along. In the first quarter of 2012, Devon reported adjusted earnings of $427 million, or $1.05 per share. This was well below the $1.34 per share in the year-ago quarter, or the $1.43 per share that analysts were expecting. Devon did set an all-time quarterly record for oil equivalent production in the quarter, but this was more than offset by slackening pricing for oil and gas, and therefore narrowed margins. Revenues for Devon in the quarter of $2.50 billion were only marginally lower than the anticipated $2.58 billion, but were 16% ahead of the $2.15 billion from the first quarter of 2011.
Devon signed a terrific deal in January of this year with Chinese Petrochemical, or Sinopac. Sinopac will provide the capital to develop shale fuel deposits, but take only a modest fraction of any realized revenues. Devon is more oil-based than Chesapeake is. Over the long run, oil will continue to rise in price as supplies dwindle. Nor can I see natural gas at $2 per unit continuing indefinitely. As a leading domestic independent producer, Devon is a good bet for today and for the long haul.
Another solid play in the independent energy producing sector is Canadian Talisman Energy (TLM). This company has operations throughout Canada, the U.S., the North Sea and also in Southeast Asia. It is that Asian business operation that sets Talisman apart. Averaged realized oil and gas prices in Asia in the first quarter of 2012 were $122.99 per barrel of oil and $9.85 per mcf of gas. Meanwhile, in North America, Talisman realized average oil prices of $77.20 per barrel, and gas prices of $2.49 per mcf. Is it any wonder Talisman is selling non-core assets, and pulling back on North American drilling in favor of Asia?
Talisman reported earnings in the first quarter of 2012 of $291 million, or $0.25 per share. This compares with losses in both the first quarter of 2011 and the fourth quarter of 2011. Looking forward, analysts have the company's earnings marching ahead at a stunning clip of 38% annually over the next five years. Predictably, that anticipated growth drives Talisman's five-year PEG to a miniscule 0.38. This is a winner for the long-term investor.
There are a number of smaller independent oil and gas companies out there. These include companies such as Triangle Petroleum (TPLM), Samson Oil and Gas (SSN) and Dejour Energy (DEJ). These companies all have less than $300 million in market capitalization. More than in most industries, economies of scale really matter in the energy production industry. Stick with the big boys.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.