Is Chesapeake’s 2014 Outlook So Grim?

Chesapeake Energy (NYSE: CHK) recently revealed its 2014 outlook. This outlook wasn’t as good as investors had anticipated and resulted in over 8% fall in the company’s stock since the beginning of the month. Is this outlook so grim? Let’s examine the company’s expected changes in production and capital expenditure for 2014 to better understand its outlook. 

Production outlook

During 2013, Chesapeake strived to augment its oil production and cut down its natural gas output.  In 2014 , the company also expects to keep moving on this direction. Its natural gas production is projected to decline by an average of 1%, year over year. Thus, its total natural gas output will reach, on average, 1,070 Bcf. Conversely, its oil production is expected to rise by 3% to 42,000 mbbls. Finally, Chesapeake’s natural gas liquids production will jump by 43% to 29,000 mbbls. Based on these numbers, the company’s total production is expected to rise by roughly 3%, year over year. Even though this growth rate is modest, it might be revised upward in the coming months, as it did last year. E.g. the company’s current estimate of its 2013 daily natural gas equivalent is set at 3,985 mmcfe — over 2% higher than its initial estimate at the beginning of 2013. Moreover, the company sold several assets during last year. After controlling for the fewer assets it has, Chesapeake’s production will increase by 8% to 10% during the year. Nonetheless, the rise in oil production is lower than it was back in 2013, which is likely to slightly cut down the company’s valuation. But the market’s reaction may have been a bit too severe especially after considering that the company expects a 10% drop in production cost in 2014. The decline in production cost could improve Chesapeake’s profit margin and thus increase its earnings.

Another issue that may have contributed to the recent drop in the company’s stock was the changes in its capital expenditure in 2014. 

Capital expenditure

Chesapeake plans to reduce its capital expenditure by 20% to an average of $5.4 billion. Keep in mind, however, that since the company sold several assets, its capex is likely to drop due to lower maintenance costs. The company didn’t break down its capex between capex allocated towards maintaining its current assets and capex allotted to increasing its production. For investors, capital expenditure translates to how much the company invests in its future growth. If the capex drops, this could suggest lower growth in production in the future. But since Chesapeake has fewer assets, this also means its capex allocated towards maintaining its existing assets will diminish in 2014. Therefore, the company’s lower capex is partly due to the fewer assets it holds. In any case, investors consider Chesapeake’s drop in capex with respect to other oil and gas producers such as Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX). Chevron’s capex sharply increased by 22% during 2013 to $41.8 billion. Looking forward, the company expects to keep increasing its capex for projects such as its LNG projects in Australia, in which 2014 is expected to be the peak year for spending on these projects. Exxon Mobil also  increased its capex by 6.8% in 2013, year over year. But the company’s capex fell by 20% during the fourth quarter. This shift puts into question the rise in Exxon’s capex in 2014. Both companies allocated roughly 10% of their respective annual capex to acquisitions. Therefore, Chesapeake’s transition towards higher oil production, reduction in capex, and the changes in its assets should be taken into context when comparing to other petroleum producers.

In conclusion…

Chesapeake’s situation isn’t so dire. The company expects to further increase its production in 2014. The drop in capex is partly due to the fewer assets and doesn’t reflect a substantial cut in Chesapeake’s investment in its future growth.

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