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Chesapeake Energy Corp (CHK) announced its second quarter earnings result on August 6, 2012. The company reported adjusted EPS of $0.06 for the second quarter of 2012, showing a decline of 92%, compared to adjusted EPS of $0.76 for the second quarter of 2011. The adjusted EPS consensus was $0.075 for the second quarter of 2012, while the reported earnings per share witnessed a deviation of -14.80% as compared to the market consensus.

The company reported revenues of $3.4 billion in the second quarter 2012, showing an increase of 3% compared to the same period last year. The reported revenues beat consensus revenue estimates of $2.4 billion, by 38.8%.

The stock is up 4% in the pre-market trading.

Production

The average production of natural gas in the second quarter of 2012 was around 3.8 billion cubic feet equivalent (Bcfe), showing an increase of 25% compared to the average daily production of about 3.1 billion cubic feet equivalent (Bcfe) in the second quarter of 2011, and an increase of 4% compared to the average daily production of about 3.7 billion cubic feet equivalent (Bcfe) in the first quarter of 2012.

Natural gas production for the second quarter of 2012 was approximately 3 billion cubic feet, which was 79% of the total production on a natural gas equivalent basis. Natural gas production achieved a growth of 18% compared to the same period last year. The company's gas production resulted in lower growth in natural gas production due to curtailments during the second quarter of 2012, and these curtailments ended at the end of the quarter.

Liquid production for the second quarter of 2012 came in at about 130,200 barrels. Oil production came in at around 80,500 barrels per day, which was about 13% of the total production on a gas equivalent basis. Natural gas liquids production was 49,700 barrels per day, which was about 8% of the total production on a gas equivalent basis. Liquid production achieved a growth of 65% for the second quarter of 2012, compared to the same period last year. Oil production achieved a growth of 88%, while natural gas liquids achieved a production growth of 37% for the second quarter of 2012 as compared to the same period last year.

The company is continuing with its shift from natural gas projects to liquid-and-oil plays, and it expects natural gas production to decrease 7%, while liquids production is expected to increase 32% in 2013, as compared to 2012.

Average Realized Prices and Hedging Gains

The average realized prices and hedging gains for the exposure taken on derivatives is given below.

Natural gas

Oil

Natural gas liquids

Natural gas equivalent basis

Average prices

$1.88/mcf

$91.58/bbl

$25.94/bbl

$3.77/mcfe

Hedging gain (loss)

$0.66/mcf

$2.09/bbl

($0.46)/bbl

$0.56/mcfe

Total Reserves

For the first half of 2012, the company added 4.2 trillion cubic feet of natural gas equivalent (tcfe) of new proved reserves, through the drilling activities undertaken by the company.

However, due to the low natural gas prevalent in the U.S., CHK revised its reserves down by 4.6 tcfe during the first half of 2012, which was due to a reduction of proved undeveloped reserves in the Haynesville and Barnett shale plays. The total proved reserves decreased 7% and were recorded at 17.4 tcfe at the end of the first half of 2012, compared to the year-end 2011.

Sale of Assets to Cover Funding Gap

CHK completed the sale of assets worth $4.7 billion in the first half of 2012, including preference shares of CHK Cleveland Tonkawa, L.L.C and overriding interests in Tonkawa and Cleveland, sale of all interest in ACMP, sale of assets in Texoma Woodford play, producing assets in Anadarko Basin Granite Wash play, and sale of other miscellaneous assets.

CHK expects to enter sale agreements for its three Permian Basin asset packages in the third quarter of 2012, and expects to achieve net proceeds of about $7 billion, and this will bring asset sales for the year to around $11.7 billion. This will be in line with the early target given by the company to achieve asset sales in the range of $11.5-$14 billion, the company revised it asset sale targets to $13-$14 billion for 2012. CHK intends to repay its term loans of $4 billion and accomplish its 25% two-year debt reduction goal to $9.5 billion at the end of 2012.

Future Production and Capital Expenditure Estimates

CHK increased its production guidance and announced a reduction of $750 million in drilling and completion capital expenditure for 2013, due to better operational performance, higher focus on optimal asset development, and continuing drilling efficiency.

Outlook

CHK is primarily a natural gas play, and the company has witnessed its profitability fall drastically YoY due to depressed natural gas prices in the second quarter of 2012.

Natural gas prices have rebounded since the beginning of the third quarter of 2012, and this trend is expected to continue going forward. This will improve the company's profitability and aid in the sale of its gas producing assets to cover its funding gap, as mentioned in its asset sale guidance referred to above.

CHK is trading at future P/E, P/B and P/S multiples of 48x, 0.71x and 1.01x, and offers a dividend yield of 1.96%. We maintain our positive stance on the stock due to its expected turnaround with debt reduction, increased oil production and rebound in natural gas prices.

Name

P/E

EPS

Dividend Yield (%)

ROE (%)

P/B

P/S

Chesapeake Energy Corp

48.35x

$2.32

1.96

10.93

0.71x

1.01x

Anadarko Petroleum Corp (APC)

19.69x

$-5.32

0.53

-13.66

1.88x

2.44x

Apache Corp (APA)

8.2x

$11.46

0.8

17.18

1.16x

1.99x

Devon Energy Corp (DVN)

16.02x

$5.10

1.42

10.49

1.08x

2.03x

Sector average (Mean)

17.62x

$2.65

2.16

968.05

119.73x

3.65x

Sector median

19.69x

$2.41

0.86

14.84

2x

2.64x

Source: Chesapeake Earnings Review: Stock Seems Geared Up For Turnaround