Why Chesapeake's Shares Could Double With Natural Gas By Winter

| About: Chesapeake Energy (CHK)
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Everyone knows that it is best to buy assets when they are unloved and cheap. The problem is that few investors want to buy a depressed asset when no one else seems to want it. However, investors like Warren Buffett and Wilbur Ross have made huge fortunes and both are now billionaires because they have bought what's cheap, and not what's popular. You don't see these brilliant investors buying the latest hyped-up IPO, but rather value-oriented assets.

Not that many years ago, gold was trading for even less than $300 per ounce, but now it is close to $1,600 per ounce. Gold is a prime example of how a natural resource asset can see a huge change in price and investor interest. It has parallels to natural gas because when few investors wanted gold at $300 per ounce, many mines were not able to produce it at a profit. But all that has changed, and a similar reversal of fortune is now possible with natural gas, especially with more valuable and readily exportable liquid natural gas.

Natural gas appears to have put in a long-term bottom and has been trending higher for the past few months. This is extremely bullish, given the negativity surrounding the global economy and financial markets. The main reason natural gas is poised for a secular rebound is simple economics:

A barrel of oil is equivalent to about 6 thousand cubic feet of natural gas. Based on this, the current price of natural gas at around $3, is equivalent to buying a barrel of oil for just about $18! This major price discrepancy is getting noticed by industry and governments. A major shift has started to occur, trucks are now being made to run on natural gas, major utilities are switching power generation to run on natural gas instead of coal, and liquid natural gas is poised for a future export boom from the United States because it is transportable and far more valuable in other countries that do not have an abundance of natural gas. There are even fears that new liquid natural gas export terminals, which are currently being constructed, will lead to a price spike for U.S. consumers since it is worth about five times as much in Asia and Europe.

A recent Forbes article summarizes the potential for natural gas to continue its rise and even more than double to $8 by this Winter, it states:

"But just as a full watering hole can deplete quickly the current gas storage glut can recede. In fact it already has been and at an alarmingly brisk pace and there may be a confluence of other events which could hasten the process."

After providing substantial in-depth analysis, the Forbes article goes on to state the catalysts for natural gas to rise to $8:

"So combine 13 year low gas rig counts, declining production levels with resultant ultralow storage injections, shut in gas production, faster than anticipated shale well declines, persistent switching from oil and coal to cheaper and cleaner gas alternatives…Then consider unending hotter than normal summer temperatures, continued greater than normal nuclear plant outages, a hurricane or two that knocks out Gulf of Mexico natural gas production for a week or two, and a La Nina induced cold winter...any one of these can light the fuse that pushes the tenuous supply/demand balance into cardiac arrest. That's the chain and it's going to lead us to $8.00 mcf natural gas by the approaching winter."

After a rough patch, it looks like both natural gas and Chesapeake Energy have bottomed-out, and with all the ingredients necessary to create a secular bull market in natural gas, it seems like investors who buy natural gas resources could be richly-rewarded, possibly sooner than most believe possible. The disparity in natural gas is clear when you consider that it sells for five times as much in Europe and Asia, and also when compared to oil. The markets are beginning to correct the undervaluation and market price inefficiencies that currently exist between countries with a new export boom. Here is a closer look at Chesapeake Energy, which could be one of the best ways to play the secular rebound in natural gas:

Chesapeake Energy Corporation (NYSE:CHK) has one of the best asset bases in the industry with high-potential projects in the Barnett Shale, Marcellus Shale and the Eagle Ford Shale. After some conflict-of-interest issues arose with the former Chairman, Aubrey McClendon, the company appointed Archie Dunham as Chairman along with new members of the board, which includes a director that has been backed by billionaire activist investor Carl Icahn. The new leadership at the company and investment by Carl Icahn are welcome signs for many investors and these recent changes are likely to keep a floor under the stock price.

Expectations remain low for this stock, but potential catalysts that could surprise to the upside include a takeover, asset sale, or joint venture, all of which appear more likely now that Carl Icahn is involved. A number of analysts believe that a major energy company like Chevron Corporation (NYSE:CVX) or Exxon Mobil Corporation (NYSE:XOM) could find Chesapeake as an attractive target because of the prime assets it controls and because of a desire to buy natural gas assets before a full rebound occurs in prices.

Short-term investors who focus only on the current price of natural gas or the depressed earnings of energy companies like Chesapeake, will miss the longer-term big picture and a chance to participate in a secular uptrend. If a deal does come for Chesapeake, it would likely jump in price and take many other stocks in the sector higher. If natural gas rises to $8, it would create a significant jump in profit margins. Whether Chesapeake shares rise due to a major jump in natural gas prices, or due to an asset sale or takeover (or both), the shares would be worth about double if the stock were to trade back near the 52-week high of nearly $34 per share.

Chesapeake appears to be one of the best ways to play a potentially huge move in natural gas because it has some of the best assets in the industry, and the share price offers plenty of value at current levels. Other companies that are also poised to benefit from rising natural gas prices include Dejour Energy (DEJ), which is about to begin a multi-year drilling program at its high-potential Kokopelli (liquid natural gas) and Rangely (oil and LNG) projects, and Exco Resources (NYSE:XCO), which has significant upside from current levels at just $7 per share, especially with billionaire Wilbur Ross invested in the company. Wilbur Ross became a director at Exco Resources in March, 2012, and he has invested tens of million of dollars in the shares, in just the past few weeks alone.

The stocks in this sector and the upside potential will be missed by investors who fail to realize that asset and reserve values are much higher than where the current share prices are trading. This sector should be bought not for current earnings potential, but for the leverage the reserves will offer in the future, as the secular uptrend continues to play out.

Here are some key points for CHK:

  • Current share price: $17.89
  • The 52 week range is $13.32 to $33.87
  • Earnings estimates for 2012: 35 cents per share
  • Earnings estimates for 2013: $1.38 per share
  • Annual dividend: 35 cents per share, which yields 2%

Data is sourced from Yahoo Finance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.