Chesapeake Energy: The Stock Acquisition Binge Continues

About: Chesapeake Energy Corporation (CHK), Includes: WRD
by: Long Player

Insiders have purchased more than 9 million shares in the last three months.

Non-market acquisitions of stock are adding to the insider accumulation.

The WildHorse Resource acquisition appears to be the key triggering event for all this accumulation.

Oil production as a percentage of total production will now grow faster.

Financial deleveraging could proceed faster than expected.

Chesapeake Energy (CHK) insiders appear to be in full acquisition mode. Everyone now wants more Chesapeake Energy stock it seems whether it is an outright purchase or through company incentive plans. Lately, the market seems to notice this trend.

Source: Nasdaq Website March 13, 2019

Sometimes, it is not the number of purchases but the overall totals of stock purchased when compared to sales. Clearly, the insiders are now very bullish on the company prospects.

Source: Nasdaq Website March 13, 2019

The market in particular appears to be focusing on some key individuals. Robert D Lawler, for example is the chief executive officer and Mr. Dell'Osso is the company chief financial officer. When people such as these officers increase their holdings, even through non-open market transactions, it tends to generate some market excitement.

This has also been coordinated with the 2.1 million share purchase by Archie Durham, the chairman of the board of the company in late December. That was the latest of several large acquisitions by Mr. Durham to increase his holdings to more than 9 million shares of the company. In fact in December alone, he purchased 4.5 million shares of the company. That is a sizable vote of confidence by an insider of Chesapeake Energy.

Oil Production Strategy

At least part of the excitement has to be due to the increasing oil production both in absolute amounts and as a percentage of total production.

Source: Chesapeake Energy January 2019, Investor Update

The company had raised the percentage of oil production to about 26% by the fourth quarter of 2018. The above slide implies another big percentage oil jump in 2019. Management had raised the oil production as a percentage of total production by gradually focusing on the more prominent liquids bearing zones.

Then at the end of the year, management sold the Utica Shale while negotiating the above purchase. The Utica Shale lease sale eliminated a fair amount of gas production from the production mix. The oil production automatically climbed as a percentage of the remaining production.

Now the acquisition of the Eagle Ford leases shown above adds more premier Eagle Ford oil lease acreage to the portfolio. There will be several more rigs drilling for oil in the current fiscal year as opposed to the Utica Shale leases. Not only does the acquisition add existing oil production, but it appears to accelerate the corporate goal to rapidly increase oil production in the future.

Oil tends to be far more profitable to produce than gas. Therefore, it does not take much of a shift to produce some decent earnings results.

Drilling Strategy

This gas producer has changed to drilling for mostly liquids. That will continue to raise the percentage of more valuable products produced.

Source: Chesapeake Energy February 2019, Investor Update

Indeed management already in their fourth quarter earnings presentation forecast guided to an increase in profitability per BOE as shown above. This update will happen simply from the increasing percentage of oil produced by the company as long as there is not a sustained (and severe) oil price decline.

A second profitability boost will come from any of the predicted merger realized savings. The last profitability boost will come from continuing industry realized production improvements that appear to add about 10% to 15% to well performance each year.

WildHorse Acquisition Accelerates Liquids Strategy

To summarize, this acquisition of WildHorse Resources (WRD) has a lot going for it without too much downside risk. Chesapeake Energy had long needed a large equity injection. This acquisition gave the company that equity injection while swapping out gas production for oil production. Long term, this acquisition should increase company profitability more rapidly.

Source: Chesapeake Energy February 2019, Investor Update

This new acquisition will receive an out-sized portion of the capital budget. The large oil percentage production and prime Eagle Ford location implies some fast paybacks. Fast paybacks allow for a fast cash flow from operations build. That is just what this company needs to move from a speculative financial structure to an investment grade rating with the ratings agencies.

The only way the company would be able to accelerate this trend would be to sell one more significant asset and use that money to decrease long-term debt. Management had announced some significant long-term debt reductions at year-end. However, the acquisition will probably boost long-term debt levels back to the amount prior to the debt reduction announcement. That makes the anticipation of a sizable cash flow build from these properties very important.

Deleveraging Importance

The oil and gas pricing is notoriously volatile and unpredictable. The only safety is a large cash flow that can withstand that volatility without endangering the corporate health and long-term outlook. Clearly, the large cash flow safety valve is exactly what this management is heading for with this acquisition.

Source: Chesapeake Energy January 2019, Investor Update

Some of the February slides appear to show management walking some of these initial forecasts back. For example, the profitability per BOE is now a little lower and that is probably a function of assumed lower oil prices. However, the trend towards investment grade rating for this company should hold up under most forecast scenarios.

The reason is that the company paid for the acquisition with mostly stock. That part of the acquisition does not have to be paid back to lenders. Instead, any profits made will be shown as increasing cash flow and earnings.

The oil mix goal for 2019 appears to have already been achieved. Management may be able to beat that forecast in the current fiscal year. Should oil prices hold in the current range (or do better) then a higher than expected oil mix implies a faster move towards financial deleveraging.

Management may be able to either sell existing leases or part of the properties purchased to immediately recoup some of the purchase price. This is an old trick to increase the profitability of an acquisition by lowering the "cost basis" of the remaining property. A move like that would also accelerate financial deleveraging and provide more capital to expand oil production.


Management appears to have jump-started a very profitable 2019. The earnings should have cash flow to confirm the validity of those earnings. The latest acquisition has given the company some financial flexibility on the path towards investment grade ratings.

Investors should probably expect another significant lease sale. Even without such a sale though, the company has a clear path to a viable future for the first time in years.

Purchases by insiders is not by itself a fail-safe gauge. Here, though, the insider purchases appear to be confirmed by a solid speculative outlook that has not been available for some time.

The insider enthusiasm shown for the shares of this company may not be perfect timing. But at this point, the purchases and non-open-market acquisitions appear to confirm a decent future ahead. For the first time in a while, long-term shareholders may do well from current levels. The insiders certainly seem to think so.

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.

Disclosure: I am/we are long CHK. 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.