Analyst Actions: Chesapeake Energy Corp Coverage Initiated With Neutral, TP of $23 at Credit Suisse

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Prisoner's Dilemma; INITIATING Coverage with a NEUTRAL Rating and Target Price of $23

Initiating Coverage: We initiate coverage of Chesapeake ( CHK ) with a Neutral rating and a $23 target price, which equates to 6.0 times our 2012 EBIDA estimate and ~80% of net asset value ( NAV ). CHK faces a prisoner's dilemma: high-return liquids growth versus balance sheet repair. In a weak gas tape, we do not believe that CHK has the means to exploit its liquids-rich acreage while deleveraging its balance sheet. In 2012, we expect shares to be volatile given gas price uncertainty, but range bound given asset value support.

Business Model Faces Key Challenge: CHK's competitive advantage is driven by its technical team, relentless land acquisition program, and use of significant scale in its drilling program, which has led to an early-mover advantage in several world-class U.S. land plays. The Achilles heel of the story has been the excessive use of financial leverage in a highly cyclical industry. CHK has argued that the long-term benefits of large-scale acreage grabs would outweigh the increase in near-term leverage; but, the magnitude of outspend is worrisome.

Deleveraging Target Appears Unattainable without Sacrificing Core Assets: To address investor concerns, CHK has pledged to further reduce its debt by $800 MM in 2012. We see challenges to meeting this goal, given its $6 billion spending gap this year, and our base case indicates that CHK will miss its target by $1.1 billion without significant additional asset sales. However, we believe CHK has the wherewithal to weather the storm, given its debt maturity schedule and a strong asset portfolio that could be rationalized as needed given the liquid market for E&P assets.

Shift to Liquids Bolsters Long-Term Positioning, but Oil Plays Are Capital Intensive: CHK shifted its emphasis towards liquids-rich plays in 2009 and has amassed the industry's largest acreage position, with more than 3.5 MM acres. While it has an abundant inventory of liquids-rich drilling opportunities, unconventional liquids plays are characterized by higher capital intensity. Therefore, the pace of CHK's development efforts are likely to be constrained until gas prices rebound, even with its significant drilling carries from JVs.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Commodities

Referenced Stocks: CHK , NAV

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