While there has been considerable speculation on where natural gas is heading and corporate governance in the oil and gas sector, not enough of the discussion has centered around market power. Investors have begun to lose touch of, for example, the valuable portfolio of assets Chesapeake (CHK) holds. This couldn't be more evident when you consider the iconic natural gas company is valued at less than one-twentieth of Exxon's (XOM) market cap despite stellar growth trends and leading positions in major gas plays. Linn Energy (LINE) is similarly undervalued and even offers a high dividend yield of 7.4% to encourage investment during these uncertain macro times. Below, I review the fundamentals of each energy company.
So much has been said about Chesapeake, that, at this point, you can almost bet on which way you think the dust will settle. In my view, the market, and certainly the media, has twisted the facts surrounding the company. CEO Aubrey McClendon is not violating regulations through putting his money where his mouth is (i.e. by personally backing the very wells Chesapeake is behind.) The company's aggressive capital expenditures are an investment that, while not as liquid as cash, have proved to be more liquid than what the market originally recognized. With Carl Icahn "overseeing" the business as an activist investor with board representation, Chesapeake is also likely to be more amenable to shareholders in the future.
The company has been busy selling off assets to improve its balance sheet and reduce risk. By the end of these sales, the company will also be more of an E&P business with top positions in Utica, Miss Lime, Eagle Ford, Mic-Con, PRB, Barnett, Haynesville, and Marcellus. I expect the company to reach a Mississippian joint venture and an asset sale announced in the earnings call. In Wells Fargo's recent equity report, the financial company estimated NAV at $36.69 per share but applied a large discount due to near-term liquidity concerns for natural gas. At some point, I believe this risk discounting will dissipate and Chesapeake will take off.
It appears that the market view Chesapeake's aggressive growth strategy as a flow. In some sense, it is concerning, specifically when you consider US laws that are pushing towards "use-it-or-lose-it" mandates. But, in my view, this increases the long-term upside. With a planned deal in the Permian and the divesture of midstream units, Chesapeake can begin to look at developing - well timed for elevating natural gas prices.
Linn is a popular stock on the street with a "strong buy" rating on the Street according to FINVIZ.com and a PEG ratio of 0.92, which indicates that future growth has yet to be fully appreciated by shareholders. EPS is forecasted to grow by 8.5% annually over the next half decade - 670 bps more than in the preceding 5.
The company is planning to increases its shareholder base through the proposed IPO of Linn Co. (LNCO). This will yield up to $1B, which will then be used to purchase stakes in Linn Energy itself. This newly formed company should receive more institutional report than current MLP I-shares, since Linn Co. will pay a cash dividend distribution.
What attracts me to Linn is its diversified holdings in liquids, which include Salt Creek, Wolfberry, Granite Wash, Cleveland, and Hugoton. At the same time, the company is rapidly hiking up production with a 40% increase in 2011 and 60%+ planned for 2012. Management is aiming to nearly double 425 MMcfe/d production in 2011 by 2015. Equipped with a strong balance sheet and a complete hedge against natural gas production through 2017, the company should be able to acquire more attractive leases. Fortunately, management is also very committed to returning free cash flow to shareholders with a leading dividend distribution that has grown 80% since the IPO six years ago. Ladenburg Thalmann believes that management can continue to increase the distribution with a cash flow coverage ratio of 1.2x.
If you are looking for safety in the oil and gas sector, Exxon is your perfect "buy". While the company has missed expectations in four of the last five quarters by an average of 4.2%, the company is still a consistent performer. It has dramatically grown EPS from just $1.62 in 2012 to $8.42 10 years later. During the same time period, shareholder value went up 149.2%.
Exxon is currently the leading natural gas producer, right ahead of Chesapeake, but is still leveraged more to oil when factoring in oil-indexed LNG volumes. Management is also cutting back on dry gas and shift towards liquids-rich unconventional plays. The firm recently acquired XTO in a deal that increased existing production by just more than 10%. Major startup projects have already geared the company towards leading peers in liquids growth.
Standard Oil heir Exxon is a tried-and-true business that is a leading capital allocator and operating of superior facilities. Higher capital returns relative to peers grant the firm a premium multiple to the rest of the market. Currently, that multiple stands at 10.6x on a past earnings-basis, but I expect to increase when the economy returns to full employment and industrialism starts to kick into full gear.
Additional disclosure: We seek IR business from all of the companies in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.