Chesapeake Energy: Why Are Analysts Consistently Off the Mark?

Chesapeake Energy (CHK) announced 4th quarter and full year earnings Thursday after the close. (Conference Call) For Q4, EPS came in at $.93 / diluted share and $3.21 / diluted share for full year 2007. Analysts expected $.81 and $3.06, respectively. Profit was down year over year due to lower natural gas prices, realized selling price was $8.43 versus $9.11 a year earlier. I recommended CHK back in July when I wrote this analysis.

It’s confounding that the 25-30 analysts that follow CHK consistently underestimate quarterly EPS results. CHK has beaten estimates for 21 straight quarters; the average surprise is 14.5%. The question is why are the analysts consistently off the mark? 21 periods in a row?

I know that forecasting earnings is a tough task as no one can accurately predict the future. But, for the past several quarters I have calculated my own estimates and my accuracy has ranged from hitting the number to being off a few cents. For 4Q07, released Thursday after the bell, the consensus was $.81, my estimate was $.91 and the actual came in at $.93. The analysts were off 12 cents.

Is it because I am a prolific forecaster? No, it’s because the numbers are out there. CHK doesn’t provide revenue and earnings guidance, but they do provide production and expense forecasts. CHK Outlook (.pdf) Applying some simple math, one can calculate an EPS figure.

I have included a screen shot of my model. In addition, a week before announcing earnings, CHK releases its production results Production Announcement. Therefore, the EPS forecast model could be refined by entering the actual production figures. Selling price and costs are still unknown, but the figures from CHK’s outlook have always been practically spot-on.

With the all the needed information available, how do the analysts continue to miss by so much? I have no clue. We know that they are highly intelligent people with considerable resources. I surmise that since they cover so many companies, sometimes it’s not feasible to keep up-to-date on every single stock in their coverage universe. Possibly, analysts don’t want to post a number that the company won’t beat, risking straining ties to the target firm. I guess it just goes to show the quality of equity research.

It’s no secret that the analysts low-ball the consensus estimate, for The Street prices-in an earnings beat each quarter. Of course, I can’t be sure that the Market does, but since shares react sluggishly, sometimes falling after topping estimates, suggests that market is expecting higher actuals.

A common pattern for CHK is moderately rising share prices in the days leading up to the announcement and continuing for a day or two after the release, and then a pullback nearly erasing all recent gains.

OUTLOOK: In my opinion, Chesapeake is attractive. The CEO, Aubrey McClendon has been on a buying spree; he bought 20 million worth of CHK in January. Ostensibly, A CEO wouldn’t snap up shares on margin if he/she didn’t think the stock was going higher. Nobody can predict future stock prices, but CEOs are in the best position. Thus, Aubrey McClendon’s purchasing record is a bullish indicator. I discussed insider buying in the article I posted in July.

CHK has massive amounts of acreage that it acquired at attractive prices. It has been ramping up drilling, and production will continue to increase drastically. Rising gas prices coupled with increasing production will provide a significant boost to revenues.

I believe gas prices should continue to increase in the years ahead. Since NG is a clean fuel, there will be pressure to use more, in place of dirtier energy sources, such as oil and coal. John Bougearel wrote a terrific analysis on NG that’s worth a read.

I believe in the long run, CHK will provide handsome returns. The stock has had a big run-up recently, and might be ripe for a pullback, thus I would probably be buying on dips.

Disclosure: I am long CHK.

Comments

[granger:]

good stuff, thanks for sharing your model

2008 Feb 24 06:09 AM

[Vegasjoe:]

I have heard more than one institutional manager comment that Aubrey and senior management pig out at the options alter as much as the worst tech stock offenders; any truth?

2008 Feb 24 07:28 AM

[User 78789:]

well done

down east

2008 Feb 24 09:54 AM

[Yael Pipano:]

additional reason insider buys will increase:
Quote from Bruce Flatt, Managing Partner and Chief Executive Officer of Brascan from 4Q'07 conf call:
"And as coal plants for electricity become more and more costly to build, because of green credits and the scrubbing and the other things that have to get added to them, and as people realize and come to the realization that nuclear takes forever to permit and to build, one of the only alternatives is to turn to gas-electricity plants to continue to generate the electricity that’s required in our most major market, which is North America."

2008 Feb 24 03:28 PM

[Turley Muller:]

swim-

I have been hearing that the investment banks & guarantors who underwrite, securitize, and place the muni paper financing construction are adverse to coal fueled plants. They recommend NG, because the fear of coming legislation and regulation on carbon emissions could significantly increase production costs.

Article

{ Three of the nation's biggest investment banks have introduced an unprecedented set of lending guidelines that could make it harder for energy companies to get financing for coal-fired power plants........... "What you've got is Wall Street now saying there are risks involved with investing in new coal plants," said Dale Bryk, senior attorney at the Natural Resources Defense Council.......Power generated with natural gas is already sold at a premium. In Florida, for example, where five coal projects have been derailed in the last year, Barry Moline, the executive director of the Florida Municipal Electric Association, looks at Tallahassee’s municipal utility as an indicator of the future.]

Demand for NG is sure to increase propping up prices.

2008 Feb 24 04:51 PM

[helplessobs...:]

Aubry is the smartest CEO in the NG exploration and production sector.

2008 Feb 25 10:37 AM

[RON$WAD:]

I HAVE BEEN A CONSISTENT BELIEVER IN "CHK" FOR OVER 3 YEARS AND HAVE MADE VERY COMFORTABLE PROFITS ON A "NO-BRAINER" - AND WHAT IS WRONG WITH MANAGEMENT USING BUY-CALL OPTIONS FOR LEVERAGE THE SAME AS ANY INVESTOR MIGHT?

2008 Feb 25 11:51 AM

[CHK Burned:]

I have owned this stock several times and have done fairly well. What continues to concern me is their high debt ratio and their ability to buy profitable companies without adding to the expense column. I think the stock is way over valued at present.

2008 Feb 25 12:48 PM

[mushrumps:]

The bottom line: CHK has been an underperformer compared SWN and EOG to name a couple. It seems like the market has a much lower opinion of the company than the CEO even as he keeps loading up. Why?

2008 Feb 25 02:23 PM

[Turley Muller:]

mush-

Good question. I would bet the CEO knows better than the market. Possibly a reason CHk has underperformed - it took on lots of debt convertible PS and there has been lots of dilution. NG trended down last year too. CHK concentrated on acquiring land instead of production past couple years- when gas was falling and land was cheaper. CHK has moved out of the acquisition phase to the asset monetization or production phase.


Aubrey's opinion is that the stock usually moves sideways for a long time, then will break out and move up to a much higher range and then move sideways for awhile. I guess similar to AMZN price history. But, he thinks CHK is on the next leg up .

2008 Feb 25 05:18 PM

[Diegojames:]

Re directed from Exxon etc into NG specifically CHK(also Terex, JOYG,NOVetc).

2008 Feb 25 10:10 PM

[Gob:]

I'm not a big fan of a company CEO playing around with options. Run the business. Hedge with natural gas futures if you need to smooth out cash flow, but mostly RUN THE BUSINESS. When you maximize core earnings, the stock price will eventually follow.

2008 Feb 26 08:54 PM