Chesapeake Is a Screaming Buy
Chesapeake Energy (CHK) announced its first quarter 2016 results on 5th May. The company had many asset purchases and sales during the quarter in the hopes of optimizing its asset portfolio. Further, there was a restructuring of debt and some amendments to the revolving facility as well.
The market has improved a lot in the meanwhile after oil touched its 13 year low in February. Oil is hovering around $ 45 per barrel and natural gas is well over $ 2.0 per MMBtu.
The company reported a net loss of $ 964 million but that was including approximately $ 853 million of non-cash impairment of the carrying value of Chesapeake's oil and natural gas properties primarily related to adjustments in oil reserves.
Asset sale and purchase:
Chesapeake has completed purchase and sale agreements worth approximately $ 1.2 billion of gross sales proceeds year to date. The net proceeds from asset sales will come at around $ 950 million. This means the company has already crossed the minimum asset divestiture target of $ 500 million for the full year 2016. In fact, it is very likely to easily surpass the upper end of the full year guidance range of an additional $ 500 million to $ 1 billion stated in the February earnings call.
Interestingly, there will be only minimal impact of these asset sales on the company’s future earnings. One of the biggest assets to be divested by Chesapeake is the one in Northern Oklahoma for approximately $ 470 million. Now, this and certain other assets are being picked for divestiture based on their being relatively smaller, non-core assets, and in this case principally non-operated acreage.
Due to this careful selection of assets, the total 2016 production is projected to be reduced by roughly 5 % or approximately 35,000 barrels of oil equivalent production per day, of which roughly 60 % of that represents gas production. Similarly, this year’s EBITDA is not expected to be reduced by more than $ 20 million using today’s strip pricing.
Debt and liquidity:
Chesapeake has already ensured enough cash flow from asset sales to provide its balance sheet the required strength from the viewpoint of its shareholders. And there are more divestment deals in the pipeline. Plus, it is set to achieve a significant CAPEX reduction this year to keep that cash free. CAPEX dropped from $ 1.36 billion to just $ 297 million i.e. an 80 % reduction in the first quarter. So the company is quite relieved on the liquidity front at the moment.
Regarding debt, the company announced the amendment of its $ 4.0 billion secured revolving credit facility agreement maturing in 2019 with its bank syndicate group. Under the amended agreement, the leverage ratio covenant has been relaxed till September 2017 and the interest coverage ratio covenant has been reduced to 0.65x through March 2017. There are certain conditions which if not met can limit Chesapeake’s borrowing capacity. But for the time being, the company has got temporary relief as its lenders won’t be redetermining the borrowing base before June 2017. At the moment, the borrowing base is reaffirmed to be $ 4 billion at least up to 31st March 2017 when its collateral value coverage ratio test will decide its borrowing capacity.
In the first quarter, the company has successfully reduced debt that matures in 2017 or that can mature in 2017 by $ 282 million.
Cost and Expenses:
Chesapeake continued to reduce its cash expenses during the first quarter. The average cost of production was $ 3.36 per boe i.e. 31 % less than the same quarter of last year and 7 % less than the preceding quarter. The G&A expenses also came down by 13 % year on year and 23 % sequentially. Together, the operating and G&A costs were down 28 % compared to the year-ago quarter.
It seems Chesapeake has seen through its bad days when it was facing risks as big as the possibility of going bankrupt. Now, with enough cash proceeds from asset sales, cost control, the amendments made to its credit facility and commodity prices getting a lot better than the last quarter, we can be sure that there is a big upside for those who buy this stock at this point in time.