"A 60:40 equity and long-only passive bond allocation has been an excellent proposition for 35 years … We deeply fear that this allocation will be risky for the next 10 years."
Sanford C. Bernstein & Company Analysts (January 2017)
"Bull markets are born of pessimism, grow on skepticism, ripen on optimism and die of euphoria"
Sir John Templeton
"Life and investment are long games of balls."
I have written a number of public papers on Chesapeake Energy (CHK) on Seeking Alpha, including these two relatively recent articles listed below.
Forgotten equity: Chesapeake builds a monopoly
Insiders prepare for Chesapeake's energy
In the first case, I mentioned the acquisition of Wildhorse Resource Development by Chesapeake, which has just closed, creating the largest position in the Eagle Ford Basin, ahead of EOG Resources (EOG), BP (BP), two weights heavy energy, following the acquisition by BHP of BHP Billiton (BHP) US onshore energy assets, Apache (APA) and ConocoPhilips (COP).
In the latter case, I referred to the heavy insider purchases at Chesapeake Energy at the end of 2018, as a result of a significant decline in CHK's common equity.
These insider purchases have generally proved timely in the short term, but in the longer term, CHK shareholders have almost universally suffered.
What will end this suffering?
The elusive generation of free cash-flow, which is finally on the horizon, as we will show below.
Energy stocks have generally suffered, especially Chesapeake, because the quality of their assets is ignored, overshadowed by constant capital requirements and the absence of free cash flow generation. This is changing.
No suspension for shareholders
Just take a look at Chesapeake's long-term graph to summarize the suffering of a large number of people and convey it in a succinct visual form.
The fact that Chesapeake's shares have strongly delayed the price gains of natural gas (in red in the graph below) and crude oil (in dark blue in the graph below) makes the pain even more unbearable. respective low energy products in early 2016.
Looking at the graph above, in theory, CHK's stock price would be tied to the underlying price gains of natural gas and crude oil price, but that was not the case up to now.
Why is Chesapeake Energy's stock price not responding?
In simple terms, energy investors are looking for free cash flow generation, and Chesapeake Energy, under the direction of Doug Lawler, who has been an excellent CEO, in my opinion, has not been able to to deliver.
What follows is the Consolidated Statement of cash flows The 2017 CHK Year-End Annual Report (10-K) shows CHK's cash flow challenges over the 2015-2017 period.
(Source: Chesapeake Energy 2017 10-K)
Looking at the above Consolidated cash flow statement some things stand out.
First, the asset write-downs taken in 2015, rising to $ 18.2 billion and in 2016 to $ 2.6 billion, due to lower commodity prices, were massive. These asset write-downs have not been rewritten as natural gas and oil prices have risen sharply. of their end – of – year levels 2015.
Second, and most importantly for our discussion, Chesapeake's Nand cash provided by operating activities (used) it was not enough to cover his The costs of drilling and completion, forcing Chesapeake to on the shale treadmill, which means they reinvest permanently in drilling, never generating free cash flow for shareholders.
Signs of progress in 2018
The rise in commodity prices in 2018, particularly the rise in the price of oil, which has to go hand in hand with oil production outside the divested assets, has allowed Chesapeake energy to make significant progress in terms of cash flow. generated by its activities in 2018, such as September 30, 2010 in CHK, CHK. Q shows below.
(Source: Chesapeake Energy Q3 2018 10-Q)
Unlike 2017, and 2015 and 2016 from elsewhere, Chesapeake's Nand cash provided by operating activities (used) through the first nine months of 2018, were enough to cover his Drilling and completion costs.
Hedging activities hurt Chesapeake Energy in 2018
Boosting the improvement in free cash flow, Chesapeake Energy suffered hedging losses in 2018 as the company's oil prices for the hedged portion of its production were significantly below market prices. .
Specifically, as the extract from Chesapeake Energy Updated August 2018 As illustrated below, most of Chesapeake's 2018 oil production was hedged at $ 54.09 per barrel, which is significantly lower than the average WTIC oil price of $ 2018, which the SEC calculated at the end of fiscal 2018, calculated as follows: $ 65.55 for 2018.
(Source: August 2018 Update from Chesapeake Energy)
Like Chesapeake Updated August 2018 As noted above, the hedged price for its hedged oil production in 2019 was higher than the hedged oil price in 2018, or $ 59.44 for 15 million barrels of 2019 oil covered by swaps, compared to $ 54.09 per barrel for oil covered.
Since then, Chesapeake Energy has not much covered its oil production because its Update of January 2019 watch below.
Looking at the above data, for 2018, Chesapeake Energy has covered about 1 million more barrels of oil production, compared to the company's production of August 2018 coverage, at prices similar to those of CHK oil production previously covered. Interestingly, about 4 million barrels of oil production in 2020 were covered at prices above $ 65 per barrel.
In summary, compared to 2018, Chesapeake Energy's hedged oil prices are higher, offset somewhat by lower natural gas prices, although they are also more exposed to the market at oil prices. While $ WTIC oil prices recently closed at $ 57.26 on Friday, February 22, 2013, up from their lows of 2019, Chesapeake Energy is able to take advantage of higher realized oil prices by to 2018. Thus, Chesapeake Energy's free cash flow generation is expected to improve in 2019, compared to 2018, which was already a much better year in terms of cash flow from operations. compared to 2017, as higher realized oil prices fuel cash flow growth.
Oil growth in 2019 should help cash flow further
In addition to improving cash flow resulting from improved hedge prices in 2019, Chesapeake Energy will benefit from oil production, which is expected to increase due to the double production of oil production. Eagle Ford oil from Chesapeake Energy, following the closing of the Wildhorse Resources acquisition in 2019, and continued growth in oil production from Chesapeake's PRB assets.
Specific to the PRB, CHK anticipates that volumes "more than double"in 2019 on 2018 levels.
(Source: January 2019 update of Chesapeake Energy)
In the January 9, 2018 of Chesapeake Energy Preliminary Report of Results and Operations for the Fourth Quarter of 2018, 2018 oil production, especially the fourth quarter of 2018 oil production, came ahead of the estimates, with oil production expected to be in the range of approximately 86,000 to 87,000 barrels of oil per day for the fourth quarter of 2018, net of assets sold from Utica, above the rate of initial targeted oil production of 80,000 barrels.
This production surprise will be further deepened when Chesapeake Energy publishes its full fourth quarter 2018 results on Wednesday, February 27, 2019, before the market opens, where Chesapeake will also give insight into its outlook for the year. 2019. If the productivity gains that led to an increase in oil production in the fourth quarter of 2018 translate into 2019, then Chesapeake may be able to surprise upward in terms of growth in oil production, cash flow and costs per barrel of production growth.
Debt Reduction paves the way for a surprise
Chesapeake Energy sold its Utica acreage, which was closed in the fourth quarter of 2018, and the proceeds of this sale were used to repay its term loan and secured second guaranteed debt, as noted above. below in Chesapeake 2018 Operation Update, published January 9, 2019, reversing the company's outlook as of 2016, when nearly all of their borrowings were forced to secure their oil and gas assets.
Adding to the good news, with the recent debt repayment, Chesapeake Energy has no significant maturity in 2019, and the shipping lane for Chesapeake's debt maturities is not as difficult as it was three years ago.
The bonds of Chesapeake Energy, which quickly recovered to reach / almost / above par, according to their maturity, after the collapse of CHK's common stock in early 2016 following fears of reorganization, experienced a much more moderate decline (note the divergence) end 2018 / early 2019. decline. Despite the much weaker decline in bond prices, CHK's bonds have recovered rapidly over the last month and a half, while the history of CHK bond transactions maturing on 15/06/2021 by Morningstar (MORN) shows.
To support this positive statement, Chesapeake's debt rating was recently improved by Standard & Poors, a division of S & P Global Inc. (SPGI). Although the debt rating still remains well below investment grade, CHK's debt rating by rating agencies has been positive, with many upgrades made by Fitch and Standard Poors since the depths of 2016.
In conclusion of this section, Chesapeake bonds, whatever their maturity date, trade at a level close to / equal to that of Chesapeake, any increase of that of Chesapeake the value of the business will flow directly into its own funds, offering one of the most unique bets on the stock market at the moment, with a higher price per share that depends on the execution of Chesapeake, with a potential for turbulent recovery due to rising prices of natural gas and oil.
With the results for the 2018 fiscal year expected to be released on February 27, the outlook for 2019 is likely to surprise the market, and any positive developments should be magnified for Chesapeake Energy's common shares, with CHK's bonds generally tied or almost. levels, and any changes in the value of the company will now be dictated by the evolution of the value of ordinary shares.
Compared with similar-sized counterparts, in terms of equivalent oil production barrels, which include Devon Energy (DVN) comparator company in Oklahoma City, Chesapeake Energy's common shares remain significantly undervalued relative to me.
In the public article Seeking Alpha linked to the beginning of this article, Forgotten equity: Chesapeake builds a monopoly, I compared the value of Devon Energy to that of Chesapeake Energy as follows.
CHK in 2020 might look a lot like DVN today.
Today, DVN transactions are trading for around 9x EV / EBITDA value, which I believe is low for DVN and a business value of around 26 billion. of dollars.
Applying a CHK-like multiple for 2020, EBITDA suggests an enterprise value of approximately $ 25 billion, less $ 8 billion of net debt, less $ 2 billion of preferred shares (rounded for debt). and preferred shares), leaving approximately $ 15 million. billion for shareholders.
After the transaction, CHK's shareholders would own 55% of the capital and WRD's shareholders, 45%, with 913 million shares outstanding today, or approximately 1.65 billion shares after the acquisition. , which implies a value of $ 9 per share on an EBITDA of 9 multiples of 2020.
With a stock price of nearly $ 3.27 today, it represents a potential upside of approximately 175% for CHK's shares for the next 18 months..
However, I think it's even conservative, because if CHK kept its forecasts, they would grow at a steady pace and, as a result, they would probably increase to a higher valuation.
Obviously, since I wrote the valuation analysis above on October 31, 2018, both oil prices and energy stocks have fallen by the end of 2018 (although the price DVN's share is quite close to its levels of October 31, 2018 as they have executed their objectives (business plan in a favorable manner according to the markets) before recovering in the first two months of 2019.
Thus, absolute and comparable valuations have generally declined. However, in this context, Chesapeake Energy appears to have exceeded its corporate plan, as evidenced by its favorable preliminary results for the fourth quarter, which could put Chesapeake Energy on a surprising trajectory in 2019.
Overall, the fundamentals still matter, the fundamentals have always been the bad scapegoat, and I am still convinced that 2019 will be a record year for value stocks because the price discovery after a decade outperforming growth, is about to come back with revenge. Specific to Chesapeake Energy, the positive fundamentals have already been digested by the bond market, which is generally perceived as the "smartest currency". Today, ordinary shareholders, who have been suffering for years, expect the return of a favorable sentiment in the form of higher share prices, which is justified by both the absolute valuations and relative.
To conclude, even though it has been very difficult for nearly 10 years for value-oriented investors, with significant outperformance pockets, especially in 2016, I think we are about to enter into an age of Gold for value-oriented active investors, do the fundamental work, which can find the future leaders free cash-flow companies, and the most disadvantaged sectors and the least favored shares, including this recent public publication will be at the forefront of this opportunity.
Thank you for taking the time to read this article,
To learn more about the changing investment landscape and where to find free cash flow companies at 15% and 20%, and to help you find undervalued and irrelevant stocks With a significant appreciation potential compared to In the overall market, consider joining a unique community of contrarians, valued investors who thrived in 2016 and withstood the storm in 2017 to come closer in as a collaborative team of experienced analysts. Together, we build The contrarian, register here to register.
Disclosure: I am / we have been for a long time CHK, BHP. I have written this article myself and it expresses my own opinions. I do not receive compensation for this (other than Seeking Alpha). I do not have any business relationship with a company whose actions are mentioned in this article.
Additional information: The situation of each investor is different. Positions may change at any time without notice. Please do your own due diligence and consult your financial advisor, if you have one, before making an investment decision. The author does not act as an investment advisor. The author's views expressed in this document relate only to certain aspects of potential investments in the securities of the companies mentioned and can not substitute for a complete analysis of the investments. The author recommends to potential and existing investors to conduct their own investment research, including a detailed review of documents filed by companies with the SEC. Any opinion or estimate constitutes the best judgment of the author as of the date of publication and is subject to change without notice.