Natural gas and natural gas stocks in general have not exactly been rewarding investors lately but Chesapeake Energy (CHK), the second largest natural gas producer in the U.S., has given investors a few extra headaches lately - namely on the corporate governance front. The SEC has even opened an investigation into those issues and shareholders have revolted, but other investors could easily take the view that the worst is now over and that everyone has done perhaps too much barking up the wrong tree. Moreover, Chesapeake Energy has been busy selling off assets with the stated intention of paying down the enormous debt it took on to buy those assets during the natural gas boom when prices were much higher than they are right now. With that in mind, should investors be asking whether Chesapeake Energy is a value stock yet or a potential value trap?
What is Chesapeake Energy?
Chesapeake Energy was founded in 1989 by Aubrey McClendon with a $50,000 initial investment and a focus on drilling horizontal natural gas wells in unconventional reservoirs in Oklahoma. The company quickly and aggressively built up a substantial position in South-central Oklahoma and Southeast Texas and then went public in 1993. Since then, the stock has produced a 1,350% or so return for investors with much of the growth coming from the years before the financial crisis when natural gas prices were sky high. In more recent years though, Chesapeake Energy has not exactly been rewarding investors because as of the first week of September, it's down close to 11% since the start of the year, down around 35% over the past year and down more than 38% over the past five years.
Nevertheless, Chesapeake Energy is still a force to be reckoned with as it's now the second-largest producer of natural gas after Exxon Mobil (XOM) and proceeding other familiar names like Anadarko Petroleum (APC), Devon Energy (DVN), Encana (ECA), BP (BP) and ConocoPhillips (COP). Chesapeake Energy is also a Top 15 producer of oil and natural gas liquids and the most active driller of new wells in the country. In fact, the company is active in most major unconventional liquids plays (e.g. Eagle Ford, Utica, Granite Wash, Cleveland, Tonkawa, Mississippi Lime and Niobrara) and unconventional natural gas shale plays (e.g. Marcellus, Haynesville/Bossier and Barnett) plus Aubrey McClendon has earned a reputation for being an outspoken advocate for natural gas.
The Controversy Over Aubrey McClendon: Much Ado About Nothing?
Aubrey McClendon has also attracted considerable controversy. Back in May, it was revealed that Aubrey was mixing a bit too many corporate interests in with his personal interests and considerable criticism was directed at Chesapeake Energy for its so-called Founders Well Participation Program that allowed him to buy 2.5% interest in most of the new wells the company drilled.
I like the idea that an energy CEO is putting his money where his mouth, or rather where his company's drill, is. What I don't like is the idea that Aubrey was borrowing hundreds of millions of dollars annually from Chesapeake Energy's financiers and others to do so as that's putting someone else's money where your shareholder's money is. Reuters had also questioned Aubrey's lavish personal spending as apparently Chesapeake Energy had footed the bill for some of this.
As Chesapeake Energy's stock began to take a hit, the Board decided to strip him of his Chairmanship and now the company is facing IRS and SEC probes along with more than a dozen lawsuits - some of which claimed the CEO was favored over leaseholders. The troubles have also fueled rumors that Chesapeake Energy could put itself up for sale but potential buyers will probably continue to shy away given these troubles or potential headaches.
Nevertheless, it does appear that the worst is over on the corporate governance front as the Board has implemented necessary changes to rein Aubrey in to the point where he can now appear in public again on company road shows - including an appearance at the Barclays CEO Energy/Power Conference during the first week of September.
Asset Sales On Track: Look for a Leaner Chesapeake Energy
At the same Barclays CEO Energy/Power Conference where Aubrey re-emerged in public, Chesapeake Energy provided an update about its efforts to sell assets (mostly natural gas drilling land) in order to help pay down some of its mammoth debt load (around $14.57 billion as of the last quarter) that was taken on during the natural gas boom years when many thought the country was going to run out of natural gas supplies.
Specifically, Chesapeake Energy reported at the conference that it expects to have sold $13 to $14 billion worth of assets by the end this year with $11.7 billion of that completed by the end of its third quarter (which ended in August but those books are not yet closed). For next year, Chesapeake Energy also expects to sell between $4.25 and $5 billion worth of assets. Nevertheless and despite all of these asset sales, Chesapeake Energy expects natural gas production to still be up 18% this year over last year.
The Final Word: Chesapeake Energy
It appears that the worst of the corporate governance issues surrounding Chesapeake Energy are over now that Aubrey McClendon has been reined in but those IRS and SEC probes could always reveal more fodder for lawsuits or further probes. Likewise and just because Chesapeake Energy is flush with cash does not mean it will use that cash to pay down most of the debt load but with a P/E of less than 7, the stock is certainly in value stock territory.
At the end of the day, Chesapeake Energy along with natural gas itself could be a value trap for investors. Just because natural gas prices have plunged to record lows does not mean they won't keep falling or that prices will suddenly rebound in the immediate future. On the other hand, cheap natural gas will also drive more consumption and conversion to it as a fuel of choice - ultimately giving it a price floor and causing prices to rise. In addition, the U.S. may have so much natural gas that it will be able to export it to other countries when or if the right government policies or infrastructure is put into place - something that may depend upon who wins the upcoming elections.
For patient investors with a long-term horizon, getting into Chesapeake Energy between now and the end of the year (as it might be smart to await the outcome of the elections as President Obama has not proved to be a friend of natural gas) may add significant value to a portfolio for the long-term.