by Matthew Smith
Chesapeake (NYSE:CHK) is a risky investment opportunity that I recommend staying away from. It is the second largest natural gas producer in the United States, but it is running into problems with its cash flow issues. In the face of a struggling economy, Chesapeake may be expanding its asset base more than it can afford. There is definite room for growth in the stock price, but I do not see the company taking the necessary steps to achieve that growth.
Aside from poor management and possibly fraudulent activity, Chesapeake is struggling with financial issues. Chesapeake currently does not have the cash flow necessary to cover its planned capital expansion. It is estimated that the company has a funding gap of nearly $9 billion. This is clearly bad news, as it means the company wants to expand more than it can afford. Competitors Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and others in the energy sector are finding most of their growth from expansion. This would suggest that Chesapeake's growth might peak if it cannot increase cash flow, so things are still not looking great for the company.
With that being said, Chesapeake is attempting to fix its cash flow margins, so it can continue expansion. The company will sell its general partner interests in Chesapeake Midstream Partners (CHKM) for $2 billion, and it also plans to sell other assets for another $2 billion. These sales should also allow Chesapeake to reduce planned future spending over the next three years by another $3 billion.
Chesapeake previously sold $3 billion worth of assets to China's Cnooc Limited (NYSE:CEO), and it is looking to sell more assets to the state-owned China Petroleum & Chemical (NYSE:SNP). Once again, Chesapeake hopes these sales will allow it to continue exploration and expansion of its natural gas production. One such expansion Chesapeake is waiting to capitalize on is the use of hydraulic fracturing, or fracking, in New York. As it makes these sales, it may finally be able to move forward.
Chesapeake is currently renegotiating 4,400 leases on land where it hopes to use fracking. The company is allowing landowners to adjust leases to gain environmental or financial benefits from Chesapeake for the use of fracking. Chesapeake is also giving the landowners the option of being released from the original contract. It plans to begin the exploration and fracking in New York once the Supplemental Generic Environmental Impact Statement is completed.
Chesapeake investors do have some reason for hope, but there is one last piece of deflating news to consider as well. The company will be forced to lay off 8 percent of its North Texas workforce, which equates to 70 employees. While this is clearly not a huge portion of the company's work force, it may be a sign of what is to come with an economy that continues to struggle. This only adds to the problems the company is currently facing, and may continue to face in the future.
I recommend staying clear of any investments in Chesapeake. To begin with, this company is being forced to sell its assets to retain decent cash flow. Another major concern is the lack of transparency that has been coming from management. New reports have continued to be released on the personal dealings of CEO Aubrey McClendon, including extravagant personal costs that have been charged to the company. With the possibility of further fraud that has negatively affected the Ohio pension plan, this company's stock could take a huge turn for the worse. While Chesapeake is attempting further exploration in hopes of finding profitable business, I cannot look past the flounders of such poor management. With this in mind, I certainly do not recommend investing in Chesapeake.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.