Chesapeake Energy (CHK) can't catch a break lately. Chesapeake is an oil and gas exploration and development company, but mostly it has lots of natural gas. It is the second largest U.S. natural gas producer after Exxon Mobil (XOM). The U.S., of course, is reaping a bonanza of natural gas produced from shale through the controversial fracking procedure.
The laws of supply and demand being what they are, the price of natural gas has been going down, briefly dipping below $2 per thousand cubic feet, to decade lows, before recovering recently.
So, Chesapeake has been losing money, more than $71 million in the latest quarter, and now faces asset sales in order to make ends meet. The company is looking to raise $11 billion, and has put some of its properties in Wyoming and Colorado up for sale.
Losing money is bad enough, but Chesapeake took a serious hit to its reputation when it was revealed that founder and CEO Aubrey McLendon had borrowed $1.1 billion, using as collateral his participation in some of the company's projects. The company was faced with questions both about McClendon's ability to make personal investments alongside the company and the failure of the company or McClendon to disclose the loans.
Another troubling revelation was the fact that McClendon had run his own personal hedge fund from company offices, trading in commodities that the company produces, which raised questions of conflict of interest. At least one analyst has compared the company's corporate governance to the disgraced and defunct Enron.
The company has said that McClendon will resign as chairman of the board, and the practice of allowing him to invest in the company's wells will be terminated. McClendon will remain as CEO; no one is proposing to kill the goose that laid the golden egg.
Is there any good news in Chesapeake's future?
Well, for one thing, natural gas prices have increased about 35% since its nadir, in a nice V-shaped turn-around, though it is still cheap by historical standards. For another, summer is coming. Since the biggest use of natural gas in the U.S. is to produce electrical energy, plenty of it will be burned to run air conditioners as this year continues its pace to be the hottest on record.
Hurricane season starts on June 1st. The National Oceanic and Atmospheric Administration has predicted only an average hurricane season, but we have had two tropical storms before the season even started. Natural gas prices reflexively increase with hurricanes in the Gulf of Mexico, at least temporarily.
Longer term, the push to use natural gas as a transportation fuel is finally bearing fruit. Companies like Waste Management (WM) and FedEx (FDX) have been converting their diesel fleets to run on natural gas to take advantage of the much lower costs. Cummins Engine (CMI) is producing truck engines designed to run on natural gas, and truck companies like Navistar (NAV) are using them in their production vehicles. Clean Energy (CLNE) is rolling out natural gas stations that will eventually run from coast to coast.
Cheniere Energy (LNG) recently received approval to export American natural gas from its Sabine Pass terminal in Louisiana. In the future, much of America's natural gas will be exported. While it is cheap here, that is not so overseas. The price of natural gas in Japan right now is five to six times what it is here. Japan is forced to import natural gas because, as of now, all of the nuclear energy plants have been shut down in the wake of the Fukushima disaster. Public distrust of the nuclear industry is so intense that it is doubtful that any of them will be allowed to reopen. Several countries in Europe have banned, at least temporarily, the practice of fracking, which will slow the development of natural gas supplies there.
Chesapeake is selling at a trailing price-to-earnings ratio of only 6.5, and below book value, reflecting pessimism about this year's earnings and a lot of headline risk. Though this year indeed looks to be not so great for Chesapeake, analysts expect the company to triple its earnings to about $1.84 a share next year. So the stock may be a value proposition.
At least some smart investors think that Chesapeake represents long-term value. In late May, BlackRock (BLK) quadrupled its stake in Chesapeake from 1 million to 4 million shares. The very next day, activist investor Carl Icahn revealed that he had increased his stake in Chesapeake to a 7.6% interest. He has also demanded changes in the board, with two board seats going to his own group and two more for another large shareholder. Chesapeake's largest shareholder, Southeastern Asset Management, has urged the company to either sell more assets or put itself on the auction block. Either move would likely result in enhanced shareholder value.
Would you want to invest on the same side as Carl Icahn? He is a legendary corporate raider, currently worth an estimated $14 billion. Of late, he has been a campaigner for shareholder's rights and for cleaning up corporate governance. Of course, it is his own shareholders rights that he is mostly concerned with, but that is to be expected. I would rather be with him than against him.
The bull case for Chesapeake is that it is undervalued relative to its assets, mainly due to temporary conditions. The price of natural gas will inevitably increase, especially as oil continues to be depleted worldwide. The bad headlines for Chesapeake will end. And you have a significant catalyst pushing the share prices up in the form of Carl Icahn's interest. I think Chesapeake is a buy now.