- Chesapeake Energy is running out of options.
- The company continues to post real losses and flattish capital net capital spending does not allow for production growth.
- The outlook is dismal with nearly $10 billion standing in a senior position to the remaining half a billion which equity still represents.
- While short squeezes might still occur, the outlook is simply dismal, unless a dramatic move in oil prices comes to the rescue sometime soon.
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I have long been extremely cautious on Chesapeake Energy (NASDAQ:CHK) as only a boom in oil and gas prices could save equity holders in the company. Investors have been lured with positive adjusted EBITDA and adjusted net earnings metrics, which do not tell the entire picture, not being that rosy.
After all, production numbers should be seen in relation to asset acquisitions and divestments, yet the major concern is that depreciation charges have been distorted by large impairments in the past. Hence, the lowered depreciation expense seems to suggests that the business is profitable, or close to being profitable in a low pricing environment. The issue is that capital spending will surpass the reported depreciation expenses in such a scenario, even to just keep production numbers flattish.
That suggests that reported profits are made undone by capital spending surpassing depreciation expenses and hence results in negative cash flows, which, in combination with the low price environment, is the reason why the stock could not escape the current turmoil.
With the stock having been decimated, let's have a look at the latest results which could not provide any relief, albeit in a very difficult market condition.
Chesapeake reported a full-year GAAP loss of $416 million and an adjusted loss at a similar number of $454 million for the year 2019. The reported EBITDAX number came in at $2.53 billion, a modest improvement from last year.
Total production for the year came in at 484,000 barrels of oil-equivalent per day, down from 521,000 in the year before as oil production rose from 90,000 to 118,000 barrels, with the fourth-quarter oil production being relatively strong. While full-year oil prices were up a few percent compared to 2018, natural gas prices were down more than 10%.
With the company still reporting losses, both on a GAAP and adjusted basis, the outlook is concerning. For the year, the company reported nearly $2.3 billion in depreciation expenses, essentially similar to the $2.2 billion capital spending number. Hence, the reported losses closely mimic the cash flows of the business and this is concerning, as production is really not growing and at best is flattish, but in reality falls a bit.
With net debt still at $9.1 billion and the company having a large chunk of preferred equity as well, it is crucial for Chesapeake to make some money which it really is not doing at the moment. Furthermore, the net debt load is still enormous, and while it has come down in absolute levels, the production base has been falling as well, meaning that in relation to production levels, leverage is not really coming. This is because there are no earnings or cash flows to reduce leverage on an organic basis, absence of an unexpected jump in oil prices.
The 2020 outlook might seem comforting with capital spending set to fall from $2.2 billion to a range of $1.3-$1.6 billion. Assuming flattish D&A expenses at $2.3 billion, that could yield $700 million to a billion in cash flow, although the company loses about $400 million a year now as well in this environment. The issue is that with the fall in the capital spending budgets, oil production is set to come in flattish, with gas production set to fall as well in 2020, although this has not been quantified.
With about a 1.7 billion share count trading at just $0.27 per share, the market value of the firm is approximately half a billion, which is just a rounding error given the net debt load of the company, let alone the enterprise value of the firm. The lack of options other than trying to stay alive on the lifeline of financiers and trying to sell assets is just buying time, as common equity holders seem to realize that no value might be left for them, unless something dramatic occurs.
Given all of this, the continued grinding lower of the shares does not seem unexpected at all to me. Note that unsecured bond prices, lower on priority compared to senior debt but ahead of common equity, have lost quite some value again as well during this rout.
Not even targeted asset sales or a reverse stock split might come as the magical solution, given the options the company has are dwindling by the day.
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