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Scott Wachsler
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I manage Wax, a baseline equity research company comprised of individual investors not licensed or registered with any government agency. I have been all cap value investor and independent equity researcher for the past 30 years, and believe that patience is the key to successful... More
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  • Chesapeak Energy - Natty or Nasty? 2 comments
    Mar 13, 2010 11:27 AM | about stocks: CHK
    A couple of days ago, Chesapeake Energy Corporation (NYSE: CHK) came up during a discussion with some friends of ours.

    Our thoughts were directed around the company as a long-term investment and were based on various articles we had read on the web, while their comments were based on their knowledge of the gas industry.

    Since they are gas traders, having spent several years on the floor of the NYMEX, we of course yielded to their expertise.

    So overnight last night, we received an e-mail from them that was a follow-up to our prior conversation, and knowing less about gas trading than a hog knows about the hereafter, we simply don't have the faintest idea what most of what was said in the e-mail actually means.

    Okay, so we understand the last sentence; but the rest of it? Not a hint.

    Here's what we received.

    "It almost reads as fiction, but we dug around yesterday, trying to figure out how CHK hedged 60%+ of their 2010 natty at $8+. The results are nothing short of astounding.

    It seems Aubrey and company has sold naked crude calls on the curve, converted the BTU’s and labeled them natty hedges, thus gaining roughly $3.50 on the hedge values. CHK, being 93% gas and only 7% oil, is basically speculating crude futures and calling it a gas hedge.

    With crude now pushing higher #’s, CHK is clinging to the rim of a toilet that just flushed, one more push up in crude and they are likely toast."

    Financial information related to the Chesapeake Energy Corporation, that is contained in this report, is based on the company's most recent Form 10-K filing for fiscal year ending December 31, 2009 as filed with the Securities and Exchange Commission on March 01, 2010.

    What They Do
    The company claims to be the second-largest producer of natural gas in the nation and the most active driller of new wells in the United States. According to management, the company's goal from the outset has been to create value for investors by building one of the largest onshore natural gas resource bases in the United States.

    Over the past 12 years, the company's strategy to accomplish management's stated goal has been to focus on developing unconventional plays onshore in the United States, where management believes the company can generate the most attractive risk-adjusted returns.

    The company also claims they have an industry-leading natural gas resource base which is integrated with an advanced drilling program coupled to an active property consolidation program, all of which is focused on small to medium-sized corporate and property acquisitions.

    During the past three years the company has shifted its strategy from drilling inventory capture to drilling inventory conversion, and in doing so has de-emphasized acquisitions of proved properties while further emphasizing its drilling program and converting its backlog of drilling opportunities into proved developed producing reserves.

    Short-Term Investment
    The stock price is currently in a downtrend. Normally, since the stock has just started to emerge from an oversold condition, we start to pay close attention to company and industry news, looking for a favorable entry point, especially since the last trading day quote was below the 13 and 50 day moving averages.

    But considering the spread of 3% between a recent close of $25.64 and first resistance of $26.51, and then considering the 4% spread between a recent close and first support of $24.60, we think that the most prudent thing to do is leave a short-term trade to those that have grown a bigger pair than we have.

    Long-Term (5 Year Hold) Investment
    We looked at the company financials, and realized that while we are certainly not the most dynamic group of folks that ever bathed with Irish Spring, we are simply mystified.

    What glazed our eyes over was the $11+ billion listed as special income charges, and, which was a new one on us, that selling and general administrative expenses exceeded the direct cost of sales by more than two to one. And while things like this may be quite normal, we have never seen such a phenomena before.

    In addition, the company has 39 subsidiaries, three of which are partnerships. While these sorts of business structures are not uncommon in the oil and gas industry, we simply aren't going to waste our time investigating all of these subsidiaries in order to determine if the company is investment worthy.

    Final Thoughts
    Our reasonable value estimate for the company is $25-$26, and should the price of the stock fall below $7, we may entertain the idea of risking a very very few dollars, admittedly more as a considered gamble than intelligent investment.

    While we still have no idea what a 2010 natty is, it makes us think that perhaps investors should adjust the angle of their Charmin a bit before they attempt to smell their fingers.


    To download the Wax Ink Chesapeake Energy Raw Value worksheet, please click here.

    Disclosure: No Position
    Stocks: CHK
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Comments (2)
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  • Karl W Miller
    , contributor
    Comments (62) | Send Message
    Comment from Mr. Miller's Office:


    What is your point regarding CHK?


    You pontificate, yet provide no new information. Remember, all that matters in the investing community is what goes in your wallet, and that is confidential to real investors.


    Also, you might be wise to educate yourselves on the "BTU Swap" market to further understand what companies like CHK, DVN, EOG, and others do regarding their proprietary hedging and trading program. Many times, a company books extraordinary income or normal income from "hedges".


    Do some homework boys and when you come back, tell us something we don't know or add some value and insight.
    14 Mar 2010, 09:50 PM Reply Like
  • Scott Wachsler
    , contributor
    Comments (163) | Send Message
    Author’s reply » Mr. Miller;


    The point of the entire post was that we don't know anything about the world in which CHK earns its money.


    Because we are value investors and basis your comments, seemingly ignorant of BTU Swaps, we are happy for experts such we perceive you to be, to show us the ropes.


    17 Mar 2010, 08:05 PM Reply Like
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