In this day and age, you expect energy companies to make a lot of money, if only because the demand for energy is at an all-time high. However, there are situations when that is not the case, and there are a few reasons for that happening. For example, take a look at what is happening to Chesapeake Energy (NYSE:CHK) right now.
The company is supposed to be riding a high, being the second largest American natural gas producer, with the report that natural gas prices are rising after a slump. But when you consider the fact that it is the subject of both an SEC investigation and massive class-action lawsuits on the belief that there are irregularities with the way that the people at the top are making their money decisions, you can't dismiss the fact that there might be something wrong with the whole operation.
In fact, speaking of the people at the top, there is also this very unsettling news item that Chesapeake is just now starting to reduce the overall compensation received by its board of directors. No investor wants to hear that a company is being investigated and the board is suddenly deciding that it may need to cut paychecks now. This is a sentiment that is borne more out of the need to react rather than a proactive notion, which begs the question: if events had not come out, would it have been willing take the same pay cuts? In an economy that is not as recovered yet, massive bonuses are frowned upon because greed was the problem before, and with Chesapeake it seems to still be the problem now.
In reality, Chesapeake still has a lot of assets, so what is the worry? Well, you have to realize that numbers are not all that impressive, especially if all you take a look at is the final number and you don't dig deeper. Amidst the fact that it has impressive revenues, you will also soon find out that it has a massive debt from Goldman-Sachs based on "strong investor demand". You'd likely believe this because-- well, more capital means that it can invest it better-- however, the strong demand may not be as strong as you initially thought.
It is always bad news when a major investor-- who has stuck his neck out for the company-- suddenly decides to sell all of his shares in the company. What could have driven it to this point? Well, you can attribute it to one factor and one factor only: mismanagement. This company is looking worse and worse by the minute, and the good news is scarce.
If all of this bad news is not enough, a big name in the rating industry, Fitch and Moody's Investors services downgraded Chesapeake's rating from BB- to BB, or three levels below investment grade. Now people can argue about what makes a company investable or not, but the fact of the matter is Chesapeake is being penalized for overaggressive capital spending. The surge in prices simply can't make up for the fact that it is spending more than is good for profits.
There is a news report that corroborates the assessment that Fitch and Moody's gave Chesapeake. This is quite scary because, as everyone knows, when you can't cover costs, you eventually will have to let go of assets. Naturally, this is what is going to happen to Chesapeake -- it is now looking at selling its assets to acquire new ones and that means that competitors will be able to get a piece of that action. One of the assets that it attempts to liquidate is shares in other companies, and these companies might just be better for it.
One of the companies that might really take advantage of this situation is Gastar Exploration (NYSEMKT:GST), a company in which Chesapeake has a 10% stake, but Chesapeake is considering selling its share of the company-- so much so that it has temporarily devalued the stock. Investors can make more money and Gastar Exploration can get more capital if people move on the company. It is growing and is generally a healthy company.
Another company in the same industry that could take advantage of a big player weakening is Linn Energy (LINE). It has just had a big "buy" recommendation score from an investment analyst's report-- for all of the things Chesapeake is not doing: spending money right and managing assets correctly.
Keep your eyes on players like Tengasco (NYSEMKT:TGC). It has just released its 1Q reports and indications are it has gained more income as it has upped its drilling operations. Investors might want to take a risk on buying either Tengasco or Linn Energy and holding on to it for the long term since it might just be more profitable and drive its value higher as a result.
These three companies, Gastar, Linn and Tengasco, have good outcomes and they might really profit from the losses of a big player, but Chesapeake is not the only company that is hobbling. Bonanza Creek Energy (NYSE:BCEI) has just been downgraded as well by Morgan-Stanley, because of assets that are growing slowly and whose upside may have been assessed improperly.
So, what is the final word on Chesapeake? Sell, and sell hard. The boat is clearly sinking and you definitely do not want to be there on its way down. Buy when the price is really low because it will bounce back, but right now it is far too risky to hold on to and expect any degree of success.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.