Is Chesapeake Heading at the Right Direction?

Chesapeake Energy (NYSE: CHK) will release its 2014 outlook at the end of this week and its fourth-quarter earnings report by the end of the month. Until these two reports will be released, let’s examine how the company has done in the fourth-quarter, compared its performance to leading oil and gas companies such as   Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX), and see how the recent developments in the oil and gas markets may affect the company’s revenue in the first-quarter of 2014.


One of Chesapeake operational changes in 2013 was to increase its oil production. In 2013, the company’s oil production is expected to reach 41 million barrels — nearly 30% higher than in 2012 .  For the fourth-quarter, the company’s oil production is estimated at 10 million barrels, which is 13% higher than in the fourth-quarter of 2012. Moreover, the average quarterly price of crude oil was 10.5% higher than last year. Therefore, taking into account these two factors, the company’s oil revenue is likely to rise by nearly 25%, assuming all things equal. In the first-quarter, however, the current price of oil is $95, which is the same price as in 2013. Therefore, if oil price remains at its current level, the price of oil won’t positively affect the company’s oil related revenue.  Let’s turn to natural gas.

Natural gas

The recent rally in the price of natural gas is likely to augment Chesapeake’s natural gas revenue in the first-quarter of 2014. During January, the average price of natural gas was roughly 35% higher than in January 2013. If the price of natural gas remains at its currently high level, this could result in a jump in the company’s revenue and profit margin. For the fourth-quarter, the price of natural gas was roughly $3.86, which is nearly 9% than the average price in the same quarter in 2012. Thus, assuming all things equal and based on the company’s output in the first three quarters of 2013, the company’s total revenue could rise by 1.3% in the fourth-quarter due to the rise in the price of natural gas. Besides the changes in oil and natural gas, the company has also regained the confidence of its investors and debt holders. This assessment is based on the recent developments in the company’s CDS pricing.

Chesapeake’s CDS continue to tumble

In recent months, the company’s credit default swap (five years, in US dollar) has tumbled down from nearly 400 back in March 2012 to 196 as of last week. The current CDS price of 196 means the yearly premium, in case of a default of $10 million of the company’s debt in the next five years, is $196 thousand. The plunge in the CDS premium indicates Chesapeake is slowly regaining the confidence of its bondholders.

The chart below shows the changes of the 5 year CDS price in the past several months (weekly prices).

CDS CHK Feb 2014Source: Bloomberg

During 2013, Chesapeake took several steps to regain the confidence of its shareholders. These steps include: selling off assets related to natural gas such as Northern Eagle Ford Shale and Haynesville Shale; reducing its financial risk by selling Chaparral Energy , a company that produces oil and natural gas and holds high debt levels , even for this industry – Chaparral’s liabilities-to-assets ratio was 0.78. In comparison, Chesapeake’s ratio was 0.62, and Exxon’s ratio was 0.51. Finally, Chesapeake has also cut down its debt level in the past year: From the first-quarter to the third-quarter, Chesapeake’s debt fell by over $700 million. These steps are likely to cut down the company’s risk and further improve its stand compared to other oil and gas companies.

The drop in the company’s CDS is also related to its performance in recent quarters. The chart below shows Chesapeake’s operating profit (excluding goodwill charges) compared to other leasing oil and gas companies such as Exxon and Chevron.

operating profitablity  CHK 2013 FebSource: Google Finance

As you can see, Chesapeake’s profitability, excluding changes in goodwill, was in line with the profitability of Exxon and Chevron.

Nonetheless, Chesapeake is still behind these companies in terms of dividend payments.  Chesapeake’s annual dividend yield is only 1.3%. In comparison, Exxon offers more than 2.8% annual yield; Chevron pays an annual dividend yield of 3.6%. In the coming quarters, if Chesapeake’s management decides to augment its dividend payment, it could draw more investors towards this company.

The bottom line 

I think Chesapeake’s management has made several changes that reduced the company’s risk and may improve its performance in the coming quarters. Finally, the recent developments in the natural gas market could benefit Chesapeake’s revenue and profitability in the first-quarter.

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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.