Overview

Chesapeake Energy Corporation (NYSE: CHK) is a producer of oil, natural gas, and natural gas liquids (NGL). The primary focus of the company is developing its portfolio of unconventional energy assets. The company owns interests in approximately 22,700 wells, and its estimated proved reserves as of December 31, 2016 totaled 1.7 billion barrels of oil equivalent (bboe).

Chesapeake has subsidiaries in a variety of downstream industries, including oil and natural gas marketing and natural gas gathering and compression. The company was incorporated in 1996 and is headquartered in Oklahoma City, OK.

Operations

Chesapeake’s primary operating segments are Exploration and Production and Marketing, Gathering, and Compression.

Exploration and Production is responsible for finding and producing oil, natural, gas and NGL. As of December 31, 2016, the company held working interests in 19,100 gross wells, and overriding or royalty interests in 3,600 wells. Of the working interests, 14,500 gross (6,700 net) wells were classified as natural gas productive wells, and 4,600 gross (2,100 net) were classified as oil productive wells.

An overview of the company’s operating areas can be found in the table below:

	State	Q4 2016 Production (boe)
Eagle Ford Shale	Texas	104,000
Andarko Basin	Oklahoma	53,000
Haynesville/Bossier Shale	Louisiana/Texas	135,000
Utica Shale	Ohio	108,000
Marcellus Shale	Pennsylvania	134,000
Powder River Basin	Wyoming	12,000

 

Marketing, Gathering, and Compression is comprised of Chesapeake’s marketing and midstream operations. Chesapeake Energy Marketing, L.L.C. is a wholly-owned subsidiary that provides commodity price structuring, securing and negotiating, gathering, hauling, processing, and transportation.

The company also has two compression-based subsidiaries, Compass Manufacturing, L.L.C. and MidCon Compression, L.L.C. Compass designs, engineers, fabricates, installs, and sells natural gas compression units. Most compressors are sold to MidCon, which operates wellhead and system compressors to facilitate the transportation of natural gas from Chesapeake-operated wells.

As of December 31, 2016, the company had sold substantially all of its assets associated with natural gas gathering.

Update on Bond Dispute

On February 20, 2013, Chesapeake attempted to exercise a special early of redemption of $1.3 billion in 6.775 percent senior notes issued in 2012. The indenture agreement stated that the notes could be redeemed at par plus accrued interest prior to March 15, 2013. However, the company was required to provide at least 30 days’ notice to the holders before initiating a redemption (which it failed to do).

BNY Mellon, the indenture trustee, challenged the redemption and claimed that under the terms of the agreement, investors were owed a make-whole payment. On July 17, 2015, the U.S. District Court for the Southern District of New York awarded BNY Mellon $380 million plus prejudgment interest of $59 million.

Chesapeake filed an appeal to the Second Circuit of the U.S. Court of Appeals, but the court ultimately affirmed the earlier ruling. On April 24, 2017, the Supreme Court declined to hear the case, effectively ensuring that the company will need to pay the awarded damages.

While the $439 million judgement is significant, the company previously recorded a $100 million charge in 2014 and a $339 million charge in 2015 related to the litigation, and therefore the impact on future profitability is limited. Liquidity should not be an issue since Chesapeake posted a letter of credit under its $4 billion revolving credit facility which is largely undrawn (with the exception of letters of credit totaling $1 billion). Accordingly, it is likely that Chesapeake’s stock price already reflects this judgment.

2016 Earnings Review

Revenue for the year ended December 31, 2016, declined 38 percent, from $12.8 billion to $7.9 billion. The company cited lower realized commodity prices, lower production volumes, and an increase in unrealized hedging losses as primary causes. Average production expense per barrel of oil equivalent (boe) was $3.05, and general and administrative expenses were $1.03 per boe. The combined average expense of $4.08 per boe for the year ended December 31, 2016, represented a 21 percent decrease from the prior year.

Overall, Chesapeake’s net loss for the year was $4.9 billion ($6.39 per share), down from a loss of $14.9 billion ($22.43 per share) in 2015. The net loss in 2016 was largely attributable to asset impairment charges of $2.5 billion, unrealized hedging losses of $818 million, and Barnett Shale exit costs of $645 million. The company’s adjusted net loss was $138 million.

At December 31, 2016, the company listed a cash balance of $882 million and total current assets of $2.1 billion. The company also listed current liabilities of $3.6 billion, yielding a working capital deficit of approximately $1.5 billion.

Following $900 million of debt repayments in early 2017, Chesapeake’s long-term debt balance was approximately $9.1 billion as of February 24, 2017. In the past year, the company has significantly reduced the amount of debt principal due in 2017 and 2018. The maturity profile of Chesapeake’s debt is shown below:

 

Cash used in operating activities for the year ended December 31, 2016, was $254 million, down from positive cash flow from operations of $179 million a year earlier.

First Quarter Earnings Preview

• Chesapeake is focused on producing 10 percent exit rate adjusted oil production growth in 2017, unloading non-core assets, and reducing marketing and midstream agreements to improve EBITDA. It will be important to monitor the company’s progress in these areas;
• In particular, investors should watch the company’s results from the Powder River Basin, a potential source of organic production growth;
• Positive cash flows from operations would help support the company’s goal of reaching cash flow neutrality in 2018;
• The current consensus estimate for earnings per share is $0.19.

 

Stock Performance

 

As of April 26, 2017, shares of Chesapeake closed at $5.47, down slightly on the day. Year-to-date, the company’s shares are down 25 percent, driven primarily by weak fourth quarter earnings. In January, Chesapeake shares traded as high as $7.32, but fell as low as $4.88 in early March. The company’s net asset value per share is estimated at approximately $6.00 per share.

Following are selected analyst ratings and price targets:

Analyst	Firm	Rating	Price Target	Date
Zach Parham	Jeffries	Hold	$6.00	3/22/2017
Paul Grigel	Macquarie	Neutral	$6.50	3/27/2017
Jason Wangler	Wunderlich	Buy	$10.00	3/28/2017
Kashy Harrison	Simmons & Company	Neutral	$6.00	4/2/2017
Stephen Richardson	Evercore ISI	Tactical Outperform	$8.00	4/19/2017

 

Summary

Chesapeake has made good progress on improving its balance sheet. It has aggressively pursued non-core asset sales to pay down debt, and has restructured existing obligations to give the company additional flexibility to invest in its highest-performing assets and grow production. Furthermore, Chesapeake has taken significant steps to control production costs and fixed charges. However, the company is still highly leveraged, and it remains to be seen how effectively it can manage the remaining asset base. A price range with a lower bound of $6.00 (approximating net asset value per share) and upside potential of $6.50 appears reasonable, which is slightly below the median analyst price target of $6.63.

 

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