Current shareholders and interested investors should look to more reliable E&P assets than Chesapeake Energy (CHK) for ROI. Chesapeake's main issues concern poor quality of corporate governance. Throughout 2012, Chesapeake has endured bad publicity and pending DOJ and SEC investigations regarding a lack of fiduciary responsibilities, CEO conflicts of interest, potential anti-trust violations, and a recent scathing Reuters report on Chesapeake's land leasing tactics. More importantly, Chesapeake has substantial debt and funding problems due to its lop-sided portfolio and the dip in natural gas prices throughout 2012. Chesapeake is now faced with divesting key assets and transitioning its focus to oil in order to maintain operations in 2013. Most viable E&Ps have already made the necessary transition to oil, and they don't face the same significant headwinds as Chesapeake.
As the second-largest domestic natural gas producer, Chesapeake should be comparable to Exxon Mobil (XOM), the top US producer. SandRidge (SD) CEO Tom Ward was the co-founder of Chesapeake; SandRidge has already transitioned its focus to liquids. Kodiak Oil & Gas (KOG) is another growth stock that trades for less than Chesapeake but has also been very successful in consistently increasing its oil production rate throughout 2012. Chesapeake's current price-to-sales ratio is reasonable but it more than doubles looking forward. Kodiak currently has the highest price-to-earnings ratio but its forward ratio is lower than Chesapeake's. Chesapeake stock is down YTD, down slightly over the past month and up 0.9% since its last earnings release.
Comparable E&P Metrics
Past 5 YR Sales Growth
EPS This Year
EPS Next Year
Chesapeake's high short ratio and high average daily volume indicate this is a popular stock that many investors choose for a short. Chesapeake's ROE, operating and profit margins are relatively weak when compared to SandRidge and Kodiak corresponding margins or Exxon's earnings. Chesapeake's the only firm of the aforementioned that has a current ratio below one. Both Chesapeake and Kodiak have similar debt-to-equity ratios, but Chesapeake has a vast portfolio of land that is currently under earning and under utilized.
In Chesapeake's recent earnings release, second quarter total revenue increased marginally to $3.38 billion from $3.31 billion, YOY. Second quarter total operating expenses increased to $2.65 billion from $2.33 billion, YOY. Net income increased to $1.03 billion from $510 million, YOY. Chesapeake finished the first half 2012 with $14.3 billion in long-term debt, up from $10.6 billion, YOY. Chesapeake's E&P segment totaled $2.1 billion, increasing from $1.79 billion, YOY. Net natural gas production increased to 275.4 bcf from 234.3 bcf, YOY; natural gas sales revenue decreased to $354 from $1.01 billion, YOY.
Oil production increased to 7.3 mmbbl, nearly double from second quarter 2011. Oil sales revenue increased to $1.62 billion from $562 million, YOY. The improved oil sales revenue was mainly due to unrealized gains from oil derivatives increasing to $955 million from $219 million, YOY. Around 79% of Chesapeake's total production was natural gas, 13% was oil and 8% was NGL. Daily production averaged 3.8 bcfe, increasing 25%, sequentially. Liquid production in first half 2012 increased 67% to 121.9 mbbls/day; Chesapeake will allocate 85% of its expenditures to increasing liquid production to 130 mbbls/day in 2012, 170 mbbls/day in 2013 and 250 mbbls/day in 2015.
Reuters recently reported details on the history surrounding Chesapeake's aggressive land grabbing tactics. This report may create similar public and regulatory scrutiny as its earlier report alleging collusion with Encana (ECA) to manipulate market land lease rates. In the least, it touches on the recent quagmire of events that led to the currently unrelated DOJ and SEC investigations. The report details how Chesapeake manipulates a 93 year-old Texas statue to obtain mineral access despite land owner's objections. Since 2005, Chesapeake has made over 1,600 requests for exceptions under this statue to gain access to minerals under landowners property without due compensation or permission; EOG requested over 1,000 exceptions and Exxon requested over 890 exceptions.
Chesapeake's spent over $31 billion obtaining 15 million acres across in the US over the past 15 years. Exxon has only spent $27 billion in this timeframe and its revenue is 35 times greater than Chesapeake's. Chesapeake recently sold around 882,000 acres to Shell (RDS.A) and Exxon for a total $3.3 billion, around half its original value. Chesapeake also sold its pipeline and related assets for $3 billion and some of its stake in Ohio for another $600 million. Chesapeake is around 85% through its target of $14 billion in divested assets for 2012, it needs around $4 billion to make it 2013.
Chesapeake is also seeking joint venture agreements for its stake in the Mississippian Lime play. Due to its corporate governance and debt issues, most major E&Ps don't look at Chesapeake as a reliable investment or partnership. It's also having a problem selling land that decreased in value due to most E&Ps already shifting away from natural gas production. Chesapeake recently announced its permanently hiring legal counsel that's been working on contract through the latest corporate gaffes. The new board's finally reviewing its executive compensation and it also recently gained more flexibility on its lending agreement. There are many more stable E&P investments to consider that have stronger growth projections than Chesapeake Energy for the near and long term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.