Chesapeake Investment Thesis

Chesapeake Energy (NASDAQ:CHK) is an Oklahoma City-based energy company that specializes in hydrocarbon exploration. The company is ranked in the Fortune 500 and became a lightning rod for environmental lobbyists due to its usage of shale fracking and oil drilling. In fact, some claim Chesapeake is among the most polluting companies in the world.

So, what’s the Chesapeake investment thesis?

The company was embattled for much of the 2010s. The U.S. Department of Justice investigated Chesapeake Energy from 2012-2014 for alleged collusion with Canadian natural gas company Encana.

It also faced felony fraud charges in Michigan in 2014, paying $25 million the next year to settle complaints.

Another $30 million was paid out to Pennsylvania landowners in 2017.

The negative run continued when then-CEO Aubrey McClendon died in a single-vehicle crash. He had been indicted by the DOJ the day prior for price fixing in Oklahoma. McClendon had a laundry list of conflict-of-interest allegations that arguably, albeit tragically, brought some relief to investors concerned about ethical leadership.

Through all of this, the company fell into Chapter 11 bankruptcy – it emerged from on February 9. 2021. Chesapeake Energy underwent a financial restructuring, and this string of tragedies could represent a discounted buying opportunity for investors willing to take the risk.

Chesapeake Market Share Small But Cash Flows Big

According to Chesapeake Energy’s 2020 10k annual report with the Securities and Exchanges Commission (SEC), production was stunted by the coronavirus pandemic. It produces four major hydrocarbons: oil, natural gas, natural gas liquids, and oil equivalents.

Oil production of 37 million barrels for the year gives it about 0.89% of U.S. oil production for the year. Its additional 163 million barrels of oil equivalent and 796 million barrel-equivalents of natural gas and NGLs makes up its full commodity production.

Barrel prices of oil are by far the most expensive commodity, but the average price of $38.16 in 2020 was a steep decline from $67.25 in 2018 and $59.16 in 2019. The decline prompted the company to pump out more natural gas to compete, and it’s relatively small in that market too.

Still, even a one-percent stake of hot commodities like this can generate big cash flows. Analysts estimate over $2 billion in cumulative free cash flow through 2026, and that’s good news for investors looking for quantifiable returns.

Does Chesapeake Stock Have a Moat?

The biggest moat involved in the industry is ownership of hydrocarbon mining claims. Although the world is moving toward green energy, natural gas, coal, oil, and nuclear are still the most viable options.

Besides fuel, petroleum is also used for plastics, clothing, toiletries, and gum among other items. And as usage of fossil fuels go down, prices are expected to trend upward. Oil is a finite resource that can’t be replenished once it’s gone, which naturally leads to higher inflation expectations.

One big advantage CHK has its existing sprawling infrastructure. The fixed cost to build what Chesapeake Energy already has is enormous and what ultimately protects it from upstart competition. And existing rivals are in the same game with the same problems levered to commodity prices.

Nevertheless, the industry is remarkably susceptible to outside forces. For example, the pandemic crashed the oil industry, and crude oil barrel prices in the U.S. fell below zero for the first time in history.

When it happened, the only real moat Chesapeake had was already going through financial turmoil. The worst financial crisis in recent history is just another day at work when you spent the preceding seven years recovering from scandal.

So long as the company continues generating revenues, it should be able to grow from the bottom it hit.

Are Chesapeake Revenues Forecast To Go Up?

Chesapeake Energy isn’t growing revenues due to the issues mentioned above with the pandemic.

In 2020, the company earned $5.29 billion in revenue in 2020, compared to $8.59 billion in 2019 and peaks of around $10.03 in 2017 and 2018.

Of course, much of this was correcting from previous issues, and the company corrected in 2021 to restructure debt.

The company has a capital reinvestment strategy of up to 70 percent of its $2 billion cash flow. It also issued $1 billion in senior unsecured notes while cutting $1 billion in annual costs from 2019 to 2021. This, combined with the company’s efforts to reduce emissions, put it in a good position to grow the top line over the next five years.

But earnings are only one piece of the puzzle, and we need to analyze the company’s income to determine if it can support more investors.

What Rate Are Chesapeake Earnings Growing?

The company’s earnings hit rock bottom last year, causing a $9.75 billion net loss in 2020. 

Chesapeake Energy hasn’t been profitable since 2018, when it earned $133 million, and it was losing money for several years leading into that as well.

Besides the company restructuring debt, it also stands to gain from the economic recovery. As travel picks back up, more oil will be needed, and Chesapeake Energy is well-positioned to increase production and sell at higher prices.

Its ability to take advantage of market conditions depends heavily on who is at the helm, so let’s examine who has led the company from rock bottom.

Chesapeake Management Quality

Robert D. Lawler took over as President, Chief Executive Officer, and Director of Chesapeake Energy in June 2013. Prior to this, he worked in several executive leadership positions for Anadarko Petroleum Corporation.

He’s joined in the C-suite by Executive Vice President and Chief Financial Officer Domenic J. Dell’Osso Jr., EVP of Exploration and Production Frank Patterson, General Counsel James R. Webb, and Chief Accounting Officer William M. Buergler.

This is the team that will be steering the company through the new economy. It has a cash runway to position itself strongly over the next five years, but there are headwinds that will push against it.

Will Chesapeake Emerge From Bankruptcy Stronger?

Chesapeake is unlikely to enjoy smooth sailing as it emerges from financial strife.

The company’s just barely recovering from multiple price-rigging scandals, and OPEC is now doing what it can to limit oil prices on a global level. Chesapeake is inherently tethered to the price of oil. Margins are squeezed severely when oil prices fall.

However, a commodity supercycle has likely begun and oil, and therefore Chesapeake – should ride the trend.

Chesapeake Investment Thesis Conclusion

Chesapeake Energy had a turbulent 20 years leading into the pandemic. It was riddled with scandals and DOJ investigations until its embattled ex-CEO left the company and eventually died in a car crash. From that point, it entered a rebuilding phase that coincided with dropping oil prices to the lowest prices in history.

Now it has restructured its debt, oil prices have risen, and the company is positioned for $2 billion in liquidity over the next five years. That means it should be able to take care of investors looking for a mid-range investment at a discounted price.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.