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Shares of Chesapeake Energy (CHK) lost almost 8% in Friday's trading session. The troubled natural gas company reported a multi-billion dollar loss. Investors were disappointed by the lack of asset sales, in order to pay off debt.

Third Quarter Results

Chesapeake Energy reported third quarter revenues of $2.97 billion, down 25.3% on the year. Chesapeake produced 381 billion cubic feet of natural gas equivalent during the quarter. Natural gas revenues fell 58% to $505 million, largely explaining the decline in quarterly revenues. Average natural gas prices fell 59% on the year. Revenues came in ahead of analysts expectations of $2.73 billion, on the back of higher production volumes.

The company reported a net loss of $2.05 billion, or $3.19 per diluted share for the quarter. The company took a $2.02 billion impairment charge related to the carrying value of natural gas properties. Impairments were driven by lower natural gas prices and uncertainty of undeveloped assets in Williston and DJ Basins.

Excluding impairments, the company reported a net profit of $33 million, or $0.10 per diluted share. This beat analysts consensus by a penny.

The report also included some disappointing announcements. Chesapeake has delayed some asset sales from the fourth quarter of 2012 into 2013, as concern about strategic investments from Asia have raised political concerns.

The much criticized CEO Aubrey K. McClendon commented on the results, "We are pleased to report our liquids production continues its impressive growth, led by a 96% year-over-year and 21% sequential increase in our oil production. Three years ago when Chesapeake was producing only 33,000 bbls per day of liquids, we embarked on a strategy to transform our asset base from one focused almost exclusively on natural gas to one that would provide more balance between liquids and natural gas production and that would likely also lead to higher returns on capital. Our current liquids production now exceeds 140,000 bbls per day, even after excluding 21,000 bbls per day recently sold in the Permian transactions. We believe the company remains on target to reach our goal of 250,000 bbls per day of net liquids production in 2015."

Production Information

Production volumes during the quarter rose 24% to 4.142 bcfe per day. Volumes increased by 9% compared to the second quarter this year. Roughly 79% of production was in the form of natural gas, or 3.286 billion cubic feet. Oil production represented 14% of total production, or 142,675 barrels of oil. The remainder of production is liquids.

Chesapeake is redirecting its drilling program from dry gas to liquids rich plays. As such, natural gas production is expected to fall 7% in 2013. Liquids production is expected to increase by 29% in the coming year. Oil and liquids have higher realized prices per energy unit.

Realized natural gas prices were a mere $1.97 per thousand cubit feet. Prices realized on oil sales came in at $90.79 per barrel, and $31.22 per barrel of natural gas liquids.

Proven reserves came in at 16.2 trillion cubic feet of natural gas, or 2.7 billion barrels of oil equivalent. Reserves are down 14% on the year on the result of lower natural gas prices which makes some reserves uneconomical to be realized. Asset sales lowered proven reserves as well. If natural gas prices were to rise back to $4.80, the average price over the past 10 years, reserves would be up 37% to 22.2 trillion cubit feet of natural gas.

Valuation

Chesapeake ended the third quarter with $142 million in cash and equivalents. The company operates with roughly $16.1 billion in long term debt, for a massive net debt position of roughly $16.0 billion.

Revenues for the first nine months of 2012 came in at $8.8 billion. The company reported a net loss of $938 million so far this year, or $1.86 per share. Earnings were impacted by a $3.3 billion impairment charge, so far this year.

The market currently values Chesapeake at $12.3 billion. This values the firm at roughly 1.0 times annual revenues. The company is likely to report a full year loss, on the back of impairment charges.

Currently, Chesapeake pays a quarterly dividend of $0.09 per share, for an annual dividend yield of 1.9%.

A Little Historical Perspective

Year to date, shares of Chesapeake have fallen some 17%. Shares traded at $25 in March, but fell to lows of $13 in May on fears that the levered natural gas company could run into financial troubles. Natural gas prices continued to tumble, impacting operating profitability of natural gas producers. Shares recovered to $21 in recent weeks and are currently exchanging hands at $18.50 per share.

The natural gas boom send shares to levels of $67 by mid of 2008, but shares fell back to lows of $11 by the end of the year. The financial crisis cut off Wall Street's financing to natural gas companies which needed to refinance debt, or tried to acquire new drilling acreages. The boost in production and financial crisis resulted in a plunge of natural gas prices.

Between 2008 and 2012 the company reported stagnant revenues at around $11.6 billion. The company reported a modest $604 million profit in 2008, followed by a $5.9 billion loss in 2009. For the full year of 2012, the company is still expected to lose money on renewed impairment charges.

Investment Thesis

Investors are not too happy with Chesapeake's latest results. The company reported a multi-billion dollar loss and the company remains under pressure. Chesapeake still has a heavy debt load and low natural gas prices prevented the company from reporting significant operating profits over the past quarter. In recent weeks, natural gas prices have recovered a bit which could boost operating profits in the final quarter of the year.

The main negative take-away from the report is the delay of asset sales. Political concerns about Asian investors and lackluster natural gas prices are delaying assets sales, originally planned in 2012 into 2013. Chesapeake previously announced to sell up to $19 billion in assets until the end of 2013. The good news is that the recent write-downs are likely a one-time item as gas prices have recovered in recent weeks. Furthermore, Chesapeake is increasing its drilling budget for the year to $8.75 billion, up from $8.0-$8.5 billion guided earlier. The company tries to boost oil and liquids production.

The equity of Chesapeake is valued at $12.3 billion. This values the firm at $4.55 per barrel of oil equivalent based on the firm's proven reserves. If natural gas prices recover, and proven reserves increase, the valuation drops to $3.33 per proven barrel. These are very low valuations, given that the company operates in a stable political area. A concern is that the majority of proven reserves is natural gas, which has lower prices compared to oil.

The lack of asset sales is unlikely to cause new liquidity concerns after Chesapeake announced a new $2 billion 5 year loan over the past week. Operating profitability is expected to increase as well for the coming quarters.

An investment in Chesapeake is quite risky, but a rebound in natural gas prices could result in some spectacular returns. I think concerns about the liquidity position are overdone.

Source: Chesapeake Energy - Delay In Asset Sales Is Disappointing