One of Boone Pickens' favorite stocks, Chesapeake (CHK) is attractive to investors due to its cheap valuation, debt reduction program and insider buying. The company is on the right track of reducing its funding gap. For that, it has sold $2.8 billion worth of its Permian basin assets to pay off 70% of its $4 billion loan. Overall, in the current year, it has sold more than $12 billion of assets to overcome the liquidity crunch and strengthen its balance sheet position. Moreover, Chesapeake, in collaboration with General Electric (GE), has launched an innovative system, called "CNG in A Box", which is being considered as an important factor for the company's success. This new technology allows natural gas to be compressed at the site of the industrial unit or filling station, and enables vehicle owners to reduce their fuel consumption by as much as 40%. After considering its bright future prospects we advice investors to take a long position in the stock.
Increasing natural gas consumption has exerted an upward pressure on the price of natural gas, which has increased by 77%, to $3.2 per mmbtu. The excessive supply of natural gas due to the hydraulic fracturing process had pushed down price to the significantly low level of $1.9 per mmbtu in the month of April. The company is a beneficiary of rising natural gas prices. The expected structural shift from oil to gas will further increase Chesapeake's drilling activities in order to meet the upcoming increase in demand. The company's management estimates that its natural gas production will increase to 1,040-1,060 billion cubic feet by the end of fiscal year 2012.
In our opinion, the company has adopted the right strategy for reducing its debt level; by selling its assets. It has sold $2.8 billion worth of its oil and gas assets in the Permian basin to pay off a $4 billion loan. The company is aiming to pay off more than half of its term loan in order to improve its balance sheet position. Its debt to equity ratio of 1.72 would improve after the company pays back this loan. Chesapeake had taken this loan in the month of May, when it was facing liquidity problems and natural gas prices had bottomed out due to excessive supply of natural gas. CHK has sold its Permian basin assets to Chevron (CVX), a subsidiary of Royal Dutch Shell (RDS.A) and Enervest. These assets comprise 6 percent of the company's production in the second quarter.
The launch of the "CNG in A Box" system is a ground-breaking development portraying its bright future prospects. In our opinion, the first mover advantage would enable the company to grab large market shares and further improves its sales trajectory. The structural transformation from oil to gas would enable the company to boost its revenue and this unique technology will significantly improve its margins as well.
Chesapeake is trading at a forward price to earnings of 14.9x, at a discount when compared to the forward P/E multiples of 16x, 17x and 55x of its peers Anadarko Petroleum (APC), Petroquest Energy (PQ) and EV Energy Partners LP (EVEP), respectively. It is trading at a Price to Sales ratio of 1x and an EV/EBITDA of 5.3x, which is at considerable discount when compared to the industry average P/S and EV/EBITDA of 4x and 7.3x, respectively.
EV Energy Partner LP
Forward Price/Earnings (Dec 2013)