Chesapeake Energy: Buy Or Sell?

Jul. 9.12 | About: Chesapeake Energy (CHK)

There has been a lot of controversy surrounding Chesapeake Energy Corporation (NYSE:CHK) lately, with many views being expressed here on this website. This brings up one simple matter; should we buy, sell, or hold this stock?

I have taken the time these past couple of days to see what the buzz is all about and whether we should get in, get out, or sit tight. There is no doubt this stock has been very volatile considering recent news, but has a turn around finally come as we saw last month, or are we ready for another dip? What I will attempt to explain is whether its run is truly up, or if this is just a bump in the road.

The Buzz

Chesapeake Energy is a natural gas and oil exploration and production company. Chesapeake is engaged in the exploration, development and acquisition of properties for the production of natural gas and oil from underground reservoirs. It also provides substantial marketing, midstream, drilling and other oilfield services.

As of December 31, 2011, the company owned interests in approximately 45,700 producing natural gas and oil wells that produced approximately 3.5 billion cubic feet of natural gas equivalent per day making it the second largest producer of natural gas in the U.S. The current market price is $20.04 with a general analyst consensus for a one-year price target of $23.56. This represents a 17.56% not including its 1.8% dividend yield.

The Numbers:

Index S&P 500 P/E 8.28 EPS 2.42 Insider Own 1.28% Shs Outstand 662.34M Perf Week 12.71%
Market Cap 13.27B Forward P/E 12.29 EPS next Y 1.63 Insider Trans 9.56% Shs Float 657.23M Perf Month 10.05%
Income 1.70B PEG 1.02 EPS next Q 0.12 Inst Own 74.48% Short Float 13.82% Perf Quarter -9.12%
Sales 12.44B P/S 1.07 EPS this Y -7.81% Inst Trans -9.96% Short Ratio 2.48 Perf Half Y -14.43%
Book/sh 24.95 P/B 0.80 EPS next Y 246.81% ROA 4.77% Target Price 25.44 Perf Year -33.55%
Cash/sh 0.66 P/C 30.30 EPS next 5Y 8.12% ROE 13.42% 52W Range 13.32 - 35.34 Perf YTD -9.36%
Dividend 0.35 P/FCF - EPS past 5Y -11.84% ROI 5.75% 52W High -43.30% Beta 1.26
Dividend % 1.75% Quick Ratio - Sales past 5Y 9.69% Gross Margin 85.54% 52W Low 50.45% ATR 0.92
Employees 12600 Current Ratio 0.59 Sales Q/Q 50.06% Oper. Margin 24.41% RSI (14) 63.19 Volatility 3.79% 4.62%
Optionable Yes Debt/Eq 0.79 EPS Q/Q 65.80% Profit Margin 15.40% Rel Volume 0.64 Prev Close 19.64
Shortable Yes LT Debt/Eq 0.79 Earnings Jul 23 Payout 13.55% Avg Volume 36.65M Price 20.04
Recom 2.50 SMA20 10.74% SMA50 17.38% SMA200 -9.92% Volume 23,349,052 Change 2.04%
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The Competition:

Price

Market Cap

Revenue

Gross Margin

Net Income

CHK

20.04

12.87B

12.44B

0.44

1.70B

APC

65.51

32.73B

14.07B

0.81

-720.00M

BP

39.63

125.60B

384.63B

0.15

24.36B

COP

54.75

69.23B

235.11B

0.22

12.34B

Industry

N/A

63.56M

24.60M

0.67

n/a

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APC - Anadarko Petroleum Corporation; BP - BP plc; COP - ConocoPhillips; Industry - Independent Oil & Gas

Chesapeake's gross margin has been higher than its Industry average for each of the past five years. Also, CHK's current Trailing P/E of 8.4 represents a 67% discount to its Oil & Gas Exploring & Prod Industry average.

The Good

In 2012, CHK plans to complete its "25/25" plan, which sets two-year production growth targets at 25% while targeting debt reduction of 25%. There is no doubt this company's fundamentals are compelling and if it can keep this trend the company will continue to be in great shape. Chesapeake is a deal maker with a strong track record, and has the largest leasehold and 3-D seismic inventory in the U.S. The company is optimally positioned for gas resource plays and is better leveraged to play natural gas prices than its competitors. This is not to mention its acquisitions that have strengthened the company's reserve, production and net acre positions.

Despite the pullback in crude oil prices since early May, analysts believe the oil & gas exploration & production (E&P) sub-industry is generating strong production growth, especially onshore U.S., which will help drive cash flow growth over the next several years. For fiscal year 2012, analysts estimate that CHK will earn $0.48, but in 2013, analysts estimate that CHK's earnings per share will grow by 254% to $1.70.

The stock has a three-star S&P rating with a bullish Moving Average Convergence/Divergence (MACD). The company is also trading higher than its ten-day moving average of $18.56, twenty-one day moving average of $18.22, and its fifty-day moving average of $17.13, which signals a bullish trend.

The Bad

Chesapeake has been in the news recently on growing concerns of its high debt levels, liquidity, aggressive capex and falling cash flow expectations. This is not to mention the recent high-level changes that come as current CEO and chairman Aubrey McClendon did not fully disclose loans from corporate lenders. Chesapeake's dangers also include weaker economic and operating conditions, a sustained decline in natural gas prices, funding concerns, and difficulty replacing reserves.

The company is expected to outspend cash flow by $4 billion in 2013, and if gas prices stay weak into 2013, it is likely the company will have to resort to further asset sales. Natural gas accounts for about 83% of CHK's production, therefore if the natural gas markets weaken, CHK's stock could underperform in comparison to its peers.

Further, Chesapeake's failure to create favorable joint partnerships may severely damage the company's ability to meet capital expenditure obligations, growth targets, and financial commitments. One last form ofuncertainty is Government policy and administration. There have been changes in the tax rates in various countries, especially in the regions the company operates.

Conclusion

Yes, the debt and uncertainty levels are very high. However, I am still bullish on this stock and the industry as a whole. I believe natural gas is essential to the success of our future. The U.S. has large quantities of natural gas and if the prices of oil start to rise again, pressure will mount to use other resources such as natural gas, which would place Chesapeake at an advantageous position, given it is the second largest producer of natural gas in the U.S.

Chesapeake's EPS is expected to grow substantially next year and in the following five years. There are also bullish expectations on the industry. However, I would not recommend jumping in right away, since I feel the stock is headed lower. I believe the stock will fall to $16, and will be a strong buy at those levels. I do not think this is a stock to ignore for long-term growth.

Disclosure: I am long CHK.