by Robert Gordon
Chesapeake Energy (CHK) is an upstream oil and natural gas exploration and producing company. Historically, it has been among the largest natural gas producers in the United States, trailing only Exxon Mobil (XOM). As of late, it has been in the news for many terrible reasons and one intriguing reason as well. The intriguing news first; Carl Icahn has acquired a 7.6% stake in Chesapeake. Mr. Icahn has long been a supporter of natural gas for transportation uses, and a leading advocate of wind power for electrical uses. At least that was before the bottom fell out on gas prices, falling by over three quarters of its value between 2008 and 2012 to scarcely over $2.00 per mmBTU.
In that environment, not only has wind energy suffered, so have natural gas producers. Chesapeake is the nation's second largest natural gas producer, and might be expected to use this price lull to further advance its market share. However, the macro problems that have befallen the company have greatly depressed its stock price, and opened it to outside investors such as Mr. Icahn.
Icahn is certainly not a newcomer to Chesapeake. He took a large stake in the company back in 2010, and his relationship with Chesapeake founder and CEO Aubrey McClendon goes back many years. In 2010, Icahn saw an undervalued company, and at one time, he held as much as six percent of the company's stock. At that time, he insisted on changes in Chesapeake's board and management, as Icahn saw Chesapeake needed to get the company's debt load under control.
Since 2010, not only did Chesapeake not really change its speculative ways, it was further dragged down by the continued fall of natural gas prices, as well as by its own CEO McClendon, who was allowed for years to use Chesapeake assets as his own piggy bank. But most damaging of all was McClendon's and Chesapeake's inability to adjust to changing market conditions. Through much of the last decade, when gas prices were higher, Chesapeake paid top dollar to achieve vast holdings of shale formations, totaling some 15 million acres across the country. Now that Chesapeake is in a significant cash crunch, it cannot expect to raise the same money for these properties as it paid for them upon their sale. It is sort of like having bought a home in Miami in 2005.
Chesapeake's debt load engendered by all of these overpriced real estate purchases have made the company leveraged to the price of natural gas. As the price plunged, Chesapeake lacked the cash flow to service that debt. It took out a loan in early May for $4 billion from Goldman Sachs (GS) and Jeffries Group (JEF) to buy some time, and now has a meeting with its main creditors to discuss the $9 to $10 billion in assets that Chesapeake must sell to raise the necessary cash to service the debt and capital requirements, and that will surely involve some of its most valuable assets.
It is Icahn's style to take an activist role to the benefit of all shareholders. In this situation, his goal is to have four outside directors of his choosing join the Chesapeake board. McClendon, who for years had not just been CEO but also Chairman of the Board, was stripped of his board position in early May. There is ample reason to suspect his days as CEO may be numbered as well.
The only good solution to Chesapeake's situation is a rise in natural gas prices. And while I cannot predict the future, we are some years away of seeing the $5 per mmBTU upon which Chesapeake had forecast its cash flow projections. This is a train wreck of a company that is best avoided
Compare the foibles of Chesapeake with the oil and gas industry's largest field services company, Schlumberger (SLB). Not only does the company have over $4 billion cash on hand, along with a top notch credit rating, its worldwide reach allows it to juggle assets effectively to match market needs.
But the case for Schlumberger is simple. Any look at any chart and it shows that as oil futures prices go, so goes Schlumberger's stock price. The stock price has fallen from about $77 per share in late March, down to about $64 per share in late May, a drop of 17%. This drop was caused by a similar drop in oil prices, with the price of West Texas Intermediate Crude suffering a historic drop in price to levels during May, not seen since 2008. Schlumberger far outspends its rivals in research and development spending, with 2012 spending anticipated at about $3.5 billion. It is also important to note that there are some signs of recovery in North American natural gas prices. As gas prices are now so relatively inexpensive, there has been a huge boost in utilities' use of the fuel, which if continued, should help to sop up domestic inventories. Also, remember that the natural gas glut and depressed price is a local condition only; European and Asian prices for natural gas are far higher. China may be on the verge of exploiting its world leading shale gas assets.
It is foolish, in my opinion, to count on oil and gas prices at depressed levels for long. We have seen patterns in the past of fuel prices stepping backward, sometimes aggressively, before advancing again to all time high prices. Oil and natural gas prices are tied to supply and demand for finite resources. Not next year, not next decade, but eventually, and sooner if worldwide economic growth advances, there will be supply squeezes and substantial price hikes. Schlumberger has seen it all before, and this massive, worldwide company has the knowledge and capital to take advantage of that long-term scenario. I know of no better buy it and forget it stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
