Chesapeake Bankruptcy Now An Option (NASDAQ:CHK)

34.87K Followers

Summary

Oil prices fall as Saudi Arabia launches oil price war.
Hedges will help in short term, but 2021 would be ugly.
Reverse split ratio may need to be increased even more.

Over the last five months, I've been cautioning investors in Chesapeake Energy (NASDAQ:CHK) about the potential share price losses due to a possible reverse split. Management issued a going concern warning with its Q3 2019 results, and oil and gas prices did not do well into year's end. While I haven't been one out there calling for the company to go bankrupt to this point, recent events may now make that situation inevitable.

Last week, OPEC was unable to come to an agreement on a deal to reduce oil production levels as demand is dropping due to the impact of the coronavirus. This was mainly due to Russia being unable to come to terms with other member countries. Over the weekend, Saudi Arabia launched an all out price war in an effort to push as many barrels to the market as possible.

Saudi Aramco, the Saudi state producer, lowered its April pricing for crude sales to Asia by $4 to $6 a barrel and cut prices to the US by $7 a barrel. For the month of February, the country produced a little under 10 million barrels a day, but a current agreement on production cuts expires at the end of this month. That likely means the country will ramp up its production efforts, and it believes it can reach 12.5 million barrels a day. As a result, the energy complex was hammered when trading started Sunday evening as seen below.

(Source: cnbc.com commodities page, current prices seen here)

When we look at Chesapeake, the company has very little cash on the balance sheet but roughly $9 billion in principal debt. As the 10-K filing shows, there's about $1 billion due by the end of 2022 but then another nearly $4 billion due in the two years after that. The company was able to push through a major debt restructuring at the end of last year but it will be hard to do that again with such depressed prices in oil and natural gas.

Back in Q3, management said it would be cash flow positive this year thanks to a large cut in its capital expenditure guidance. That forecast was reiterated at the most recent earnings report, with natural gas production being cut, as the company had about three quarters of this year's oil production hedged. The problem is that when that forecast was given, WTI oil was around $50, Brent was over $53, and natural gas was at $1.85.

I was skeptical of the latest free cash flow forecast given how much oil and gas had come down since the previous earnings report, but the oil hedges are certain to help. The problem is that there is only so much more capex that can be cut, and now we're talking about oil down more than 35% since the earnings report in late February. The real problem is that if the Saudis are trying for a prolonged oil war, Chesapeake doesn't have any major hedges on for next year, which would be when things get really bad at these prices.

Like most energy names, Chesapeake has not done well over the past year, falling considerably as the chart below shows. The prolonged fall below $1 a share has caused the name to need a reverse split to remain a listed stock. At roughly 22 cents a share as of Friday's close, I would have expected a 1 for 25 ratio at the minimum to get shares back into good graces. But with this major oil price fall, that minimum ratio likely will need to be 1:50.

(Source: Yahoo! Finance)

In the end, the chances for Chesapeake Energy to enter bankruptcy soared over the weekend as Saudi Arabia launched an oil price war. With energy prices plunging as a result, Chesapeake may not produce positive cash flow, and there's a lot of debt coming due in the coming years. Management did a good job putting oil hedges on for this year, but if this energy shock remains in place for a while, 2021 will be very ugly for this company.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

This article was written by

Bill Maurer

34.87K Followers

I am a market enthusiast and part-time trader. I started writing for Seeking Alpha in 2011, and it has been a tremendous opportunity and learning experience. I have been interested in the markets since elementary school, and hope to pursue a career in the investment management industry. I have been active in the markets for several years, and am primarily focused on long/short equities. I hold a Bachelor of Science Degree from Lehigh University, where I double majored in Finance and Accounting, with a minor in History. My major track focused on Investments and Financial Analysis. While at Lehigh, I was the Head Portfolio Manager of the Investment Management Group, a student group that manages three portfolios, one long/short and two long only. I have had two internships, one a summer internship at a large bank, and another helping to manage the Lehigh University Endowment for nearly a year. Disclaimer: Bill reminds investors to always do their own due diligence on any investment, and to consult their own financial adviser or representative when necessary. Any material provided is intended as general information only, and should not be considered or relied upon as a formal investment recommendation.

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