Chesapeake Energy: Mr. Market Does Not Care About Cash Flow

Summary

• Finally some cash flow. But not near enough to service the debt.
• Long-term debt is still approximately $10 billion.
• Great well results have not filtered into comfortably increasing production.
• Those forecasted asset sales have not materialized on the scale and price needed to be helpful.
• Gathering, processing and transportation expenses are still way out of line. Interest expense is burdensome.

Finally, Chesapeake Energy (NASDAQ:CHK) manages to actually produce some cash flow from operations and the stock drops. Lately, it seems like all the stock does is drop. To convince Mr. Market otherwise, the company needs to follow this quarter with ever increasing cash flows or a lot of very convincing asset sales. That may be a tall order, but it is at least speculatively possible if management is willing to think outside the box and get creative along the lines of Rick George when they were bailing out Obsidian (OBE).

Source: Chesapeake Energy Third-Quarter 2017 Earnings Press Release

The market concerns are neatly summarized by the two slides above. The third quarter this year is the first time since the third quarter last year that operations generated a significant amount of cash flow. The problem is that the third quarter last year was the only quarter to generate cash flow. So the market may be afraid of a repeat performance. Cash flow has not been adequate for some time. Management has yet to definitively guide to adequate cash flow. Up until now, decent cash flow has been in the indefinite future.

The result is that long-term debt has not changed all that much since the beginning of the year when the bank line balance is included. Mr. Market is getting frustrated by the lack of progress.

This company has about $10 billion in debt. Despite all the ballyhooed progress, there has been no tangible progress on the debt removal for too long. The latest press release shows record production results of individual wells and all sorts of partial debt progress. But the overall picture remains the same and it's depressing.

Source: Chesapeake Energy Third-Quarter 2017 Earnings Press Release

Most companies in the situation of Chesapeake Energy try to either grow their way out of debt or sell enough assets to relieve the financial pressure caused by the debt. A very creative few manage to exchange a lot of debt for equity.

In the case here, the production is simply not growing fast enough to enable the company to increase cash flow enough to manage the debt load. Despite some record wells in the Utica Shale, Eagle Ford and elsewhere, production is just not growing appropriately. Production is still below where it was a year ago. In fact, production is only now beginning to show some significant growth. If management can repeat those record wells to the extent that production grows a lot more, then some financial pressures may ease.

But if the financial pressures do not ease, then management may have to propose an equity-for-debt swap on a grand scale. The odds against such a proposal succeeding are pretty steep. The credit rating agencies definitely do not like that. But the continuing lack of cash flow progress and asset sales progress may make this the last viable option.

Source: Chesapeake Energy Third-Quarter 2017 Earnings Press Release

There has also been a lack of progress on the cost control front. Gathering, processing and transportation expenses remain sky-high. In the past, eliminating some of those sky-high costs has been extremely burdensome. Usually those one-time payments eliminated cash flow from operations.

The other expense handicapping profitability is the interest expense per BOE. That amount may not be as significant as Denbury Resources (DNR). But this company really cannot afford any interest expense at the current time. Interest expense is now beginning its climb as the perceived lending risk of the company increases.

"The company's total debt balance on October 31, 2017 was approximately $9.9 billion, including $643 million drawn on its revolving credit facility and the company's total liquidity was approximately $3.1 billion."

"On October 30, 2017, the administrative agent under the company's senior revolving credit agreement, in addition to other lenders under the agreement, notified Chesapeake that the borrowing base had been reaffirmed at $3.785 billion."

- Source: Chesapeake Energy Third-Quarter 2017 Earnings Press Release

The first quote shows that the company has made little overall debt progress since the start of the year. In fact, management's debt payments at the beginning of the fiscal year have now been effectively reversed.

The banks though have a problem. This company has quite a lot of debt. So if the banks push too hard, the resulting losses to the lending group and other debt holders could be sizable. On the other hand, most likely interest rate increases are in the future and borrowing base use restrictions will probably increase. The days of a SandRidge Energy (SD) drawing down the credit line before filing bankruptcy are now over. So the borrowing base reaffirmation may not be quite what the announcement makes it out to be. Still though that announcement is far better than the potential alternatives.

Summary

Management has got to show progress for the common to be a viable investment. The preferred appears to be a subpar investment consideration at the current time as well. Other vehicles appear to offer better returns with far less risk. Even the bonds at the current time do not appear to be much of a value. Though the bonds may be a better deal than the common at the current time.

Management needs to show that it can generate enough cash flow to consistently service the debt. Selling properties for an adequate price appears to be an unreachable goal at the current time. That could change in the future. But the common stock will remain a volatile trading vehicle until management shows progress. Otherwise no sound case can be made for a long-term holder of the common.

There is a speculative hope that enough operational improvements would bail management out of the current debt load. That is very speculative though. Management has been announcing record well results for some time. Yet those record well results have not translated into comfortable production increases.

As long as cash flow remains inadequate, the securities of this company may be too risky for the average investor to consider for an investment. Some extremely well-trained traders could have a field day with the current stock volatility and possible future volatility. Right now though the risks continue to outweigh the possibilities. The market is rightly focused on the lack of progress. Remaining on the sidelines may be the best course for investors at the current time.

Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.

Analyst’s 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.