Chesapeake Energy Corporation (NYSE: CHK ) analysts expect CHK to turn a profit of 75 cents per share this year. Next year, that could easily rise to above $1 per share. Its sales growth should average 15% a year in the next couple of years and total sales could reach $11 billion by the end of 2018. Even with depressed oil prices, Chesapeake Energy is well on the way to doubling.
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According to an article in the Economist magazine last year, more than 90% of producers can turn a buck even if oil prices fall to $30 per barrel.
That's because oil-rich countries, such as Iran and Saudi Arabia, operate national oil giants that can extract a barrel of oil (or an equivalent, such as natural gas) out of the ground for less than $10 per barrel. U.S.-based shale producers have production costs closer to $15 per barrel.
The above helps explain why OPEC, the giant oil cartel, hasn't had much luck with cutting production to try and boost oil prices. Even at $50 per barrel, which is still half what it sold for a couple of years ago, most producers can still make a profit by producing at their existing wells.
The Appeal of Chesapeake Energy
Chesapeake Energy shares currently trade at just over $6 per share, so at first glance the single digit price-earnings ratio looks quite compelling. Unfortunately, the company is being punished for its past when it spent billions of dollars buying oil and gas fields back when energy was booming and oil prices were around $100 per barrel.
That buying binge resulted in a rather large write-down of many properties in its portfolio. In 2015, it wrote off $18.2 billion of those investments and lost $22.43 per share. It also pushed shareholders' equity (or book value) into negative territory, meaning the company has lost money for shareholders since it was founded.
Yet, the company has stayed in business, and conditions are improving. Last year's loss was only $6.45 per share (compared to $22.43 previously) and debt is being whittled down by asset sales. Total long-term debt ended last year below $10 billion. Its gas properties are valued on the books at $66.5 billion, and its total portfolio qualifies it as one of the largest natural gas producers in the United States.
Shale gas producers, or those that rely on fracking to extract oil and gas from the ground, have proven frustratingly resilient to OPEC. They continuously innovate to lower production costs and stay afloat, even though energy costs remain depressed.
Despite its past overinvestment at the peak of the market, Chesapeake Energy is still a major player in the industry. Yet the market still has concerns about its survival.
CHK plans to reduce debt by $2 billion to $3 billion "over the next few years through additional asset sales." It has a net-debt-to-Ebitda (one of the most common ways to analyze how large a firm's debt load is) goal of 2x, which would make its overall debt load quite manageable.
As with most companies, future cash flow is key for CHK stock. But in Chesapeake's case, it is especially important. Its stated goal is to "achieve cash flow neutrality in 2018."
Bottom Line on Chesapeake Energy
Debt-rating firm Moody's has a positive outlook on much of Chesapeake's outstanding debt. It has noted that the company is reducing debt and plans to generate positive cash flow as soon as is reasonably possibly. It sees plenty of available liquidity, meaning the firm should be able to continue to raise debt as needed.
Moody's would likely downgrade Chesapeake's debt if production growth slows again, cash flow goals aren't met or liquidity dries up. These situations seem unlikely, and the fact the company is expected to report a profit while oil prices are low, is encouraging.
As with most energy producers, Chesapeake Energy would breathe a huge sigh of relief if oil prices increased from current levels. A jump to $60 a share or more in oil prices could cause CHK stock to rally rather significantly, as earnings would increase further and liquidity concerns would be further allayed.
But as it stands currently, even with $50 oil, CHK should be able to work to improve its balance sheet and boost cash flow. If it can keep its operations stable, shares could easily double from current levels, and that would represent an earnings multiple in the low-teens, based off analyst profit expectations from next year.
Chesapeake's low P/E also compares favorably to rivals. Range Resources Corp. (NYSE: RRC ) trades at more than 30 times earnings expectations for 2018. Antero Resources Corp (NYSE: AR ) is more reasonable at 17x for the same period, but this is still well below Chesapeake's multiple.
Investing in CHK stock represents a higher risk/higher potential reward play in the industry. Trouble could appear if oil happens to slide back toward $30 per barrel. In this respect, safer and more diversified players, including Exxon Mobil Corporation (NYSE: XOM ) or Bp plc (ADR) (NYSE: BP ), make more sense.
As of this writing, Ryan Fuhrmann was long CHK stock.
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