Please follow this link to read my previous articles about Chesapeake Energy.
I did not expect Chesapeake Energy's (NYSE:CHK) stock price to go below $5 when I recommended that it should be bought at below $7. My expectation was that $6 will work as a strong support for the stock price as it had already fallen a lot. The stock price was falling despite consistent improvement in the fundamentals, especially, the balance sheet had shown a lot of progress. I still believe that it is a solid turnaround story and this story will take another two years to complete its first phase.
The stock price will remain under pressure in the short-term as Chesapeake Energy's stock price has always been highly correlated to the commodity prices. At the moment, oil and gas have both come under pressure which has allowed the traders to affect the stock price. However, my investment theses for Chesapeake is based on recovery in the commodities market, improving fundamentals and operational efficiency. I have been advising a long-term approach, as like any other turnaround story, the road to recovery will be bumpy. Shareholders should not pay too much attention to the fall in stock price and wait for the story to complete by the end of 2018.
Changes in the short-interest over the month of February show how negativity has prevailed. At the start of the month, Chesapeake's short interest was less than 28% of the free float. This value went up to over 33% by the end of the month. And the days to cover went up from 2.8 to 3.5 in the space of these four weeks. Total shares sold short rose to 134.6 million from 111 million. Oil price was range bound during this period while natural gas futures were showing a downward trend. Traders were successful in using these market conditions and the current price trend shows their bets paid off. However, these trades were helped by the negative movements in the commodities market, which I believe will be short-lived and the market will show a solid recovery in the next few months. As the market recovers, short-covering might result in a quick rise in the stock price. Elevated short interest has created a trading opportunity, in my opinion.
Chesapeake Energy has made a lot of improvements to its capital and cost structure, which I have explained in my previous articles (linked above). The second component of my theses is the overall market conditions. This is where shareholders will have to be patient and if they do not panic, then there is a prospect of substantial gains. In fact, current stock price might offer an opportunity for the long-term investors to bring their cost basis down.
Natural gas and oil prices have come under pressure for different reasons. Natural gas price started to fall in December and by the start of February, it was down by more than 30%. The reasons were hotter than expected weather and increase in inventories.
However, as the summer is approaching, the price has again started to go up. Natural gas is getting an increasingly important role in US power generation, and its consumption will again increase in the next few months. As a result, I believe the price will hold over $3. The future of the natural gas market is not bleak. US has the cost advantage which is allowing it to become a dominant player in the Asian LNG market. At the moment, only one LNG terminal is operational. However, by 2020, this number will rise to five which will allow the country to export as many as 500 tankers a year. LNG exports coupled with the natural gas exports to Mexico will continue to push natural gas inventories down and prices will rise. Chesapeake is still predominantly a natural gas player. So, the dynamics of the natural gas market are favorable for the overall health of the company.
Oil is facing its own challenges. As the US inventories have been rising, the price has come under pressure. Rising price resulted in increased drilling activity, which was coupled with the lower refinery intakes. As a result, US inventories have been rising faster than expected. It is important to remember that the OPEC members and their partner countries have shown an extremely high compliance to the supply cut agreement. Most of the international agencies are maintaining that global excess supply will vanish from the market by the end of the year. OPEC and its partners have also shown willingness that they will extend the supply cut agreement beyond June if it is needed. Only the US inventories are rising which has spurred a bearish sentiment in the market. US data always has a profound impact on the global markets, so it is not surprising that the markets are behaving this way. However, as the major players are willing to take the necessary steps, I believe the oil price will recover and reach around $60 by the end of the year.
Oil around $60 and Natural gas above $3 will make Chesapeake profitable. Decreased production might be a negative for the company. Lower volumes at higher prices will still yield satisfactory results. The company has ample liquidity and there are no major debt payment obligations in the short-term. The management's efforts to eliminate short-term debt maturities have positioned the company nicely for growth. Current stock price is an opportunity to bring the cost basis down as I do not believe it will remain at these price levels for long. Chesapeake shareholders should be patient and ride this storm. It should be held for at least two more years to take full advantage of the turnaround story.
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.