Chesapeake Energy Corp. (CHK:US), battered by a glut-driven collapse in natural-gas prices and growing investor distrust of its management, still is the cheapest way of buying into the U.S. shale revolution.
Investors can lay hands on the equivalent of one barrel of oil reserves from Chesapeake for $3.58, compared with $9.07 a barrel at Devon Energy Corp. (DVN:US) or $30.47 at Continental Resources Inc. (CLR:US), the dominant player in North Dakota’s crude-rich Bakken Shale, according to data compiled by Bloomberg. On a price-to- cash flow basis, Chesapeake also is less expensive than any other major U.S. shale explorer.
Now that the board of the Oklahoma City-based company has said it will remove Chief Executive Officer Aubrey McClendon from the chairman’s post and examine his personal transactions for any conflicts, analysts such as Bob Brackett at Sanford C. Bernstein & Co. said the focus is on how well the CEO follows through on promises to raise cash by selling assets in Texas, Oklahoma and Kansas. An incipient gas rally also portends well for a company whose output is 81 percent gas and that holds reserves vast enough to satisfy four years of U.S. household demand.
“Chesapeake is going to bounce back,” said Gianna Bern, president of Brookshire Advisory & Research Inc. in Chicago, who owns shares of Chesapeake’s publicly traded pipeline business, Chesapeake Midstream Partners LP. (CHKM:US) “There is no substitute for good geology and Chesapeake has leading positions in many of the richest American shale plays.”
Largest Onshore Leaseholder
Chesapeake is the largest holder of onshore drilling leases with 15.6 million acres under its control, an area half the size of New York state. The company has amassed the biggest leaseholds in 11 of the 15 richest U.S. oil-shale formations, and three of the four biggest gas-shale regions. Chesapeake held proved reserves at the end of 2011 equivalent to 3.13 billion barrels of oil.
Chesapeake lost 43 percent (CHK:US) of its market value in the past year as new wells in shale fields unleashed more gas than utilities, manufacturers and residential consumers could burn. The supply surplus, aggravated by a mild U.S. winter that curbed furnace usage, pushed prices to a 10-year low of $1.902 per million British thermal units on April 19.
The stock had its steepest drop in three years on May 2 as investors punished the company for an unexpected $71 million first-quarter loss and concern about conflicts between McClendon’s personal finances and professional duties.
Inquiries Under Way
Chesapeake was the best performer on the Standard & Poor’s 500 Energy Index (S5ENRS) today. The shares rose (CHK:US) 1.2 percent to $17.39 at the close in New York. Chesapeake’s price-to-cash flow ratio is less than half of Devon or Chevron Corp. (CVX:US), according to data compiled by Bloomberg. Range Resources Corp. (RRC:US), which drills shale formations in Appalachia, has a ratio more than seven times bigger.
The board is examining whether McClendon’s use of personal stakes in company-operated wells as collateral to obtain hundreds of millions of dollars in loans put the CEO at odds with shareholders’ interests. Chesapeake is searching for someone outside of the company to replace McClendon in the chairman’s spot.
The U.S. Securities & Exchange Commission has opened an informal inquiry, according to a company statement yesterday. Investigators will look into whether McClendon failed to disclose possible conflicts of interest, a person briefed on the matter said on May 2, asking not to be named because the matter isn’t public. Chesapeake and McClendon are cooperating.
Tom Nelson, who has $13.5 million in Chesapeake shares among the $450 million he co-manages at Guinness Atkinson Asset Management Ltd. in London, is looking past the corporate- governance dust-up to what a recovery in U.S. gas prices will mean for Chesapeake’s cash flow (CHK:US) and profits.
Gas on the Rise
“One thing that everyone is choosing to discount is a continued recovery in the gas price,” Nelson said in a telephone interview yesterday. “If and when that comes to pass, and we think it will in the next 24 months, then Chesapeake is in a very strong position.”
The gas recovery may already have begun: The benchmark futures contract on the New York Mercantile Exchange rose 19 percent in the past two weeks to settle at $2.291 per million British thermal units. By the first quarter of next year, the price is expected to reach $3.60, based on the median of nine analysts’ estimates compiled by Bloomberg, 53 percent more than yesterday’s closing price.
The glut isn’t going to last long because power generators in the U.S. are burning gas at a rate not usually seen until June, said Ben Smith, president of First Enercast Financial, a Denver-based gas broker. As utilities eschew coal in favor of cleaner burning gas, Smith expects domestic gas demand to meet or exceed the record levels reached during June to September 2011.
Debt Reduction Outlook
“I’m very bullish on gas,” Smith said in a telephone interview yesterday. “We’re seeing a significant demand response. Any price under $3 is too low.”
Even with gas close to a 10-year low, Chesapeake expects to fulfill its pledge to reduce net debt to $9.5 billion by the end of this year from $12.6 billion at the end of the first quarter, Jeffrey L. Mobley, Chesapeake’s senior vice president of investor relations and research, said in a telephone interview yesterday.
After raising $2.6 billion from asset sales during the first four months of this year, the company plans to sell another $9.5 billion to $11 billion in oilfields and other properties, including everything it owns in Texas’ Permian Basin, Mobley said.
“Our plan is still intact and on track to achieve the goals we set forth,” Mobley said.
Some analysts, such as James Sullivan of Alembic Global Advisors in New York, are cautioning investors that Chesapeake’s stock may be prone to volatile swings for some time to come.
“We think there’s going to be a lot of headlines in the weeks and months to come and we’d rather let some of that get resolved first,” Sullivan, who initiated coverage of the company May 2 with a neutral rating, said in a telephone interview yesterday. “We’re also looking to see some concrete action on debt reduction and some of the other financial metrics.”
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