Chesapeake Is Set To Reach Double Digits Soon

| About: Chesapeake Energy (CHK)

Summary

Haynesville shale asset sale will further enhance the debt profile.

Cash balances will be boosted.

Improved debt metrics, rising commodity prices and leaner asset base will push the stock higher.

Good news continues to flow for Chesapeake Energy (NYSE:CHK). The stock was already on a strong rally after the OPEC production cut when the management announced another natural gas asset sale. Divestitures have been an important tool of restructuring for the company in the last two years as it has been trying to get though one of the worst slumps in commodity prices. This asset sale comes at an appropriate time for the company as it will further give support to the recent rally. It looks like the stock will finally start its sustained rally towards double digits.

78,000 net acres are being sold in Haynesville shale through this transaction. 40,000 of these are what the company classifies as "core" acreage. At first, I was a bit surprised at the company's decision to sell its natural gas assets producing assets when the natural gas prices are on the rise. Keep in mind that these assets are producing and the company will be losing 250 wells. Natural gas production will take a hit of 30 million cubic feet per day. Natural gas prices are now above $3.6/MMBtu. January 2017 futures are trading at $3.69 . Looking at the 30-day chart, we can see that the market has been extremely bullish in the last four weeks. Natural gas prices have gained more than $1 or 38% in the last month.

Source: Nasdaq

With this trend, the decision to sell natural gas producing assets looks a little surprising. However, the management must have been working on this deal for months and they might not have been able to foresee the rise in natural gas price. In addition to this, the company still has more than 250,000 acres in the core Haynesville area and these assets are likely to push production growth up from this area. Despite this sale, Chesapeake management is expecting 13% growth in production from Haynesville assets in the next year. There is another sale planned from the same area. The company will be selling 50,000 acres from the northern area of the Haynesville shale. The projected growth in production for 2017 takes into account the second sale, which is likely to happen in the first quarter of the next year.

The financial aspect of this deal is more important as these sales are mainly for debt repayment and liquidity enhancement. Total proceeds from this transaction will be $450 million. This will beef up the cash balances of the company which had come down to just $4 million at the end of the last quarter. However, looking at the cash balances on 10-Q will be misleading. At the start of October, the company closed a private placement of $1.25 billion worth of unsecured notes. As a result, the cash balances reached $1 billion. These cash balances and the proceeds from this sale will sufficiently cover the debt repayment obligations during the next twelve months. There have been a lot of movements regarding the debt of the company. The image below shows the changes in debt over the last twelve months.

Source: 10-Q

Chesapeake has brought down its near-term debt maturities substantially. Only $532 million worth of debt is due in 2017, at the end of the third quarter. There might be some further reductions in these amounts as the company tries to use the sale proceeds from this transaction. Both sales from Haynesville shale will be sufficient to cover the debt obligations in the next year. However, the management might want to save some of the cash for working capital. Despite a favorable trend in commodity prices and rising revenues/cash flows, the company will need this cash for working capital. Chesapeake is still some way from cash flow neutrality and the management will need to preserve cash.

There is a possibility that the oil market turns from oversupply to deficit in the next year, according to the International Energy Agency. If this happens, then we can see oil prices hitting $65-70 in the next twelve months. Oil prices at these levels and natural gas prices close to $4 will result in a significant boost in cash flows. It is also important to remember that the management still plans to sell more non-core assets in the next twelve months. Proceeds from these sales and cash flow boost from rising commodity prices might prompt further debt repayments. This will help the company meet its targeted debt reduction.

Another aspect of rising commodity prices which I have talked about repeatedly, and a lot of people forget is that the rising prices will affect the valuation of assets. As the oil and gas prices have been on an upward trend in the last 7-8 months, the strip prices for end of the year proved reserves valuation will be higher. This is the same calculation that results in impairments (non-cash expense) if the commodity prices are falling. Since the prices have been rising for the majority of the year, there is a chance that the valuation for most of the assets will be revised. Some of these assets will now have a higher value which will enhance the strength of the balance sheet. This will also result in stronger collateral for the current and any future loans.

Debt metrics are going to improve by the end of the year. There has been a substantial reduction in near-term debt which means that the cash flows will be under less pressure. Also, the adjusted EBITDA figure will improve due to the better realized prices for both natural gas and oil. Reduced debt and rising EBITDA will have a double impact on the ratio. Favorable market conditions, improved debt profile and strong cash balances give Chesapeake a solid platform to make progress. These fundamental improvements will translate into appreciation in stock price. I see Chesapeake crossing $10 in the next few months.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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