Chesapeake Energy – As Good As It Gets
Posted on: July 19, 2008 - Email Article - Printable Version
Chesapeake Energy Corp. [CHK: 25.42, 0.00 (0.00%)] is an independent oil and gas producing company that specializes in natural gas production. Based in Oklahoma City, OK, Chesapeake has the benefit of being located directly in the heart of America’s new natural gas boom. Their exposure to shales along with their recent flurry of transactions from their CEO to create shareholder value have caused the market to undervalue the company by a large margin. Recently, the stock price has suffered a setback at the expense of the entire energy sector and the broader market. This pullback should provide investors with a very inexpensive way to play the coming natural gas boom while allowing them to hedge their own personal energy costs.
Valuation
Chesapeake is one of the cheapest natural gas companies within the entire industry, highlighted by their astounding growth rates for a company of its size.
- Market Capitalization – $29.36B
- Trailing P/E – 15.89x
- 2008 P/E – 13.45x
- 2009 P/E – 12.40x
- 2008 PEG – 1.01
- EV/EBITDA (ttm)- 10.25x
- 5 Year Estimated Growth Rate – 13.33%
- Debt to Equity (mrq) – 1.07x
The industry averages for natural gas exploration and production companies are trailing P/E’s of 21.79 and PEGs of 1.15. What is even more important for Chesapeake than their sound fundamental valuation is their shale exposure and their recent activities.
Growth Drivers – Shale Exposure
Their are four major onshore natural gas shales in the United States; Haynesville, Fayetteville, Marcellus, and Barnett. Going forward I would rank these in the order above in terms of growth prospects and how lucrative they may be for those companies that have exposure to them. Chesapeake’s total proved and risked unproved reserves are massive, especially relative to their market capitalization:
- Haynesville Shale – 12,836 Bcfe (Billion cubic feet equivalent)
- Fayetteville Shale (Core Area) – 10,029 Bcfe
- Barnett Shale – 8, 235 Bcfe
- Marcellus Shale – 1,943 Bcfe
These numbers do not include the other 27,037 Bcfe in other areas and the 130,000 Bcfe in unrisked unproved reserves of which the Haynesville Shale has potentially 25,600 Bcfe alone. Using Friday’s closing natural gas price of $10.57 per MMBtu (a thousand thousand British Thermal Units) you can see how potentially valuable these reserves are. One MMBtu is equivalent to 1,000 cubic feet of natural gas so each Bcfe equals 1,000,000 times the spot price of natural gas. If you exclude unrisked unproved reserves CHK’s assets have a total spot market value of $635,045,600,000.
Obviously it is important to remember that there are costs involved and Chesapeake doesn’t recoup anywhere close to 100% of that value, but with a number that large even a small to average sized percentage is almost unfathomable. In their latest investor presentation, Chesapeake said that during Q1 2008 they were able to to keep the total cash cost of each Mcfe produced to $2.13, which leaves a $8.44 cash profit margin per Mcfe before adding in other non-production expenses such as hedging derivatives and non-cash based stock compensation among other things.
In a recent joint conference call with Plains Exploration Company [PXP: 31.74, -0.22 (-0.69%)] after the announcement of their new deal, Chesapeake’s CEO Aubrey McClendon stated the following values associated with each shale:
- Haynesville Shale – $16.5B or $30/share
- Fayetteville Shale – ~$12B or $25/share
- Marcellus Shale – $15B or $30/share
- Barnett Shale – $11B or $20/share
- All other production – $35-$40B or $50/share
That is a share price of $155 and the CEO believes that is today’s fair share price.
Why the steep discount?
This is an interesting question and one that I nor anyone else has all the correct answers to regardless of how much research they tear through. Firstly, it is likely that Chesapeake is setting up to do something big in the near future as made evident by some of their recent transactions. They have raised an unbelievable amount of cash over the last month or two.
- 7.17.2008 – Chesapeake sells 90,000 acres in their Arkmoa Basin Woodford Shale to BP PLC [BP: 57.18, +0.60 (+1.06%)] for $1.75B.
- 7.8.2008 – Chesapeake offers 28.75M shares at $57.25 to raise $1.65B.
- 7.1.2008 – Chesapeake sells 20% of it’s Haynesville Shale assets to Plains Exploration Company [PXP: 31.74, -0.22 (-0.69%)] for $1.65B in cash and another $1.65B in capital expenditure costs being covered by Plains on Chesapeake’s remaining 80% share in Haynesville.
- 6.23.2008 – Goodrich Petroleum [GDP: 18.53, +0.41 (+2.26%)] buys a 50% non-operating interest in a 5,800 acre block of Haynesville for $3.3M.
- 6.16.2008 – Chesapeake pays Goodrich $178M for an undisclosed amount of Haynesville assets.
- 5.20.2008 – Chesapeake offers $2B in senior notes due in 10 and 30 years.
- Chesapeake also has $2.0B available in their revolving credit facility according to their most recent investor presentation.
The quick math on this says Chesapeake has raised $10.7B since their last quarterly report. Many people are speculating that Chesapeake has raised this cash to do one of a few things:
- Pay down debt which is currently at $12.25B as of their last quarterly report
- Participate in more transaction to acquire more acreage
- Increase capital expenditures for 2008, 2009, and 2010 so that they may increase production
- Acquire another company
Many investors are speculating that Chesapeake is interested in buying Petrohawk Energy Corporation [HK: 21.45, -0.16 (-0.74%)]. With the cash that Chesapeake has raised recently, this is not out of the question. Chesapeake would have to pay a premium for Petrohawk because many believe that the price of natural gas is only going up from here as we are in the traditionally lower half of the seasonal cycle for natural gas pricing.
Chesapeake is also a notorious hedger. Aubrey McClendon doesn’t like to take wild risks in the commodity spot markets and generally hedges around 75% of all Chesapeake’s production every year. Based on their current book of derivatives and collar hedges Chesapeake would actually make more money in 2008 with natural gas at $10.00 per Mcfe than any higher number because they wanted to lock in spot prices which at the time were well above historical averages. Because natural gas spot prices traded way above this level for a good portion of Q1 and Q2 2008, it is very likely that Chesapeake will have one-time hedging related charges that could swing their free cash flow for the quarter to a negative number. This is generally nothing to be alarmed about but the markets don’t like it at all. I recommend this as a buying opportunity based on historical analysis because whenever natural gas prices drop below Chesapeake’s hedged average value Chesapeake can make amplified returns when other companies suffer for not hedging their production. This occurred in 2005 and 2006, whereas the opposite has occurred from the middle of 2007 through today. Chesapeake has been able to take advantage of the extremely volatile natural gas spot price and enter into new hedging contracts at much higher prices than in previous years.
Other Factors
Even with the threat of a potentially large acquisition looming, investors have to trust Aubrey McClendon as he has beaten guidance for at least the last 25 quarters and delivered on every promise he has made. He has been buying up shares as quickly as possible recently in huge blocks (often over $1M per purchase) and it is very likely that he is going to run the company in the best interest of the shareholders as he owns 33,452,911 shares as of July 15th, 2008 valued at ~$1.82B as of the market closing price on Friday, July 19th, 2008.
Another important factor to remember is that all of Chesapeake’s production is in the United States, mainly focused in the south-eastern United States with some exposure to the east coast. None of their reserves are at risk unlike many of the world’s energy reserves that are based in areas where either the political situation, threat of terrorism, tax rates, or weather situation is extremely unfavorable.
This valuation also does not factor in the bullish argument for a rise in natural gas prices. Natural gas as recently as two weeks ago was trading over $13.50 per MMBtu and many experts and insiders see natural gas having rapid appreciation through the end of this upcoming winter. With the looming energy crisis that is about to strike the United States and the rest of the world, it isn’t a bad idea to invest in companies who have the physical assets that will allow the world to continue operating the way it is currently accustomed to. Chesapeake reports Q2 2008 earnings on 7.31.2008 (not confirmed) and I wouldn’t expect the stock price to remain this low after their report which is almost positive to beat consensus earnings estimates before one-time related expenses. Schlumberger Limited [SLB: 65.52, +1.21 (+1.88%)] kicked off earnings season with a great beat on Friday and I would expect most of the better energy companies to beat consensus estimates even with estimates coming up drastically over the last month.
-Charles Petredis
Disclaimer: The Author owns a long CHK position in his personal portfolio, the author’s family owns a long position of CHK, and the mutual fund he manages owns a long position in CHK as well as SLB.
The Following Stocks Were Mentioned In This Article: CHK
Comments
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Tim Ramsey
@ Tim: Thanks for commenting! You really caught us with our pants down on this one, as we have only today opened the website up to our authors to get the writing started. Glad you enjoyed the article on Chesapeake Energy, I encourage you to subscribe and check back as we will be finalizing the template over this weekend.
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