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The article was written by Yutian Fang, a Financial Analyst at I Know First and Master of Science in Finance candidate at Brandeis International Business School

“Chesapeake has built a track record of continuous sequential improvement in our business. We have delivered what we said we would deliver. The substantial improvements in our company over the last five years have not accrued to the common shareholder due to commodity price and legacy burdensome debt commitments and obligations. But as our legacy obligations have largely been removed, the common shareholder is in an excellent position from our significantly improved fundamental business model.”

-Robert Douglas Lawler, Chief Executive Officer and President of Chesapeake Energy Corporation

Source: seekingalpha.com

Chesapeake Energy Corporation (NYSE: CHK) is an American producer of natural gas, oil and natural gas liquids (NGL) headquartered in Oklahoma City. Besides petroleum and natural gas exploration and production, the company also performs marketing services for other producers and owns natural gas marketing and natural gas gathering and compression businesses.  As of December 31, 2017, it held interests in approximately 17,300 gross productive wells, of which 97% the company had working interest. The company has a diverse portfolio of unconventional natural gas and liquids assets and has two operating divisions by geography-northern division and southern division-covering six states. The company now employs approximately 2500 people and delivered a production of 200 MMBOE in the year of 2017.  “…the power and strength inside of Chesapeake is in our portfolio of assets and our talented employees,” Doug Lawler said.

Chesapeake’s operations. Source: chk.com

Market shows resurging demand and share gained by the increased shale oil production  

The 2014 oil price collapse resulted from the Saudis aggressive long-term expansion plans made the investment fall in both 2015 and 2016, where the total production in US followed the same pattern. Last year, the market has rebounded due to that the OPEC countries partnered with Russia and other producers to cut output. Market has boomed since then US production showed notable development and surge underpinned by shale oil fields and advanced drilling technology.

US crude oil production in the past five years. Source: tradingeconomics.com

Chesapeake Energy’s revenue from 2000 to 2017 (in billion U.S. dollars). Source: Statistita.com

For the next five years, markets also see strong demand from petrochemical industry and export to countries approaching middle class status. According to International Energy Agency’s (IEA) projection, the US will pump 17 million barrels of crude oil, condensates and natural gas liquids and will account for 60 percent of the oil production capacity increase. Chesapeake is the fifth-largest oil producer by volume in the country and holds high-quality unconventional oil and natural gas assets in top U.S. onshore plays. Supported by its crude and gas pipeline commitments, the company’s competitiveness also comes from the access to premium markets. Currently, Chesapeake is planning to add the fourth rig to tap the Turner formation, which is one of the most lucrative oily layers in Powder River Basin, and continues to deliver strong results-producing more than 500 barrels of oil a day one year after coming online.

Chesapeake and other four oil and gas firms saw noting successes in the Powder River Basin. Source: trib.com

Strong prospects on free cash flow generation after drawdown in debt

Because of the oil bust at the end of 2014, Chesapeake was left with huge $21 billion debt load. Holding assets in many basins throughout the country with the full weight from debt and interest it owed, it’s difficult to drill and complete to realize revenue at expected rate. Taking advantage of the upswing in energy prices, the company strategically started to reduce the debt load by entering into sales agreements for a significant portion of gathering and compression assets and replaced higher cost debt under revolving credit facility to reduce interest expense. Last year, the company’s capital structure has been simplified, the secured term debt being reduced by $1.3 billion. The operating efficiency has been greatly improved-the company’s return on assets is 13%, higher than the oil and gas average of 5.6%, and return on capital is in upward trend. The significant reduction of interest expense helped to enhance the company’s margins and promise positive free cash flow in the year of 2018.

Chesapeake’s return on capital. Source: investors.chk.com

Chesapeake’s historic free cash flows and estimate for 2018. Source: investors.chk.com

Growing market stability and well hedged position help to mitigate the systematic risks

Markets raised the forecast on oil price as the inventories are falling and global demand remains strong. The cancellation of the US’s agreement with Iran has resulted in supply disruption and the compliance between OPEC nations and Russia prompted their long-term deal to limit exports. On the other side, global economy continues its strong growth performance and OPEC revised its estimates for the demand up to 1.6 million barrels a day.  Despite recent sales, Chesapeake still holds assets that provide flexibility and options to meet the increasing demand. The company’s expected cash flow in 2018 is also largely protected by its strong hedge position. There is approximately 68% of our projected 2018 gas production hedged at $3.10 per mcf and 79% of crude oil production hedged at $52.41 per barrel to avoid the adverse effect brought by oil, natural gas and NGL prices fluctuation.

Technical analysis and analyst recommendations

The stock price shows strong upside momentum during past two months following the moving average lines of different time periods converged and intertwined, forming a firm temporary bottom. The catalyst was the announcement it had agreed to swap $153 million of debt for about 4% of its equity, which was regarded as the company’s critical move in its debt reduction efforts. However, the stock price climbing didn’t gain support from trading volume and the MACD started to show weakness and head down. At the start of this July, due to OPEC’’s report that showed increase in June’s output and worsening US-China trade tensions, the price started to reverse the direction. Chesapeake scrapped the common stock dividend to maintain capital expenditure as a response to the current commodity price environment. The price slumped by some 17% from its peak to the time of writing, consecutively breaking through the supporting lines. In the short term, the concerns on the volatility in global production still cast shadow on the stock price movements.

Source: StockTA.com

Source: Yahoo Finance

Most of analysts from Yahoo Finance who monitoring this stock tend to be conservative on the stock performance in the foreseeable future.  In April, there are 19 out of 31 analysts gave their recommendations to hold.

Current I Know First algorithm forecast for CHK

Go here to read how to interpret this diagram.

I Know First algorithm issued a bullish algorithmic forecast for CHK on July 15th, 2018. The signals for terms of one month, 3 months and 1 year suggest positive perspectives on the stock future performance. The signal for one month is 11.69, indicating a less bullish view on short term when compared to longer forecasting periods. In the long run, the predictability becomes strong, as high as 0.66, a very high confidence level given for our forecast.

Past I Know First forecast success with CHK

As the issued on May 15^th , 2018, I Know First made accurate forecast on CHK with its bullish 7-day performance.

The stock outperformed in the Stocks Under 5 Dollars package with 26.11% gain in 1 week. On May 24^th, we pointed out the facts and analysis explaining the stock performance, which demonstrated our previous forecast.

Conclusion

In the short term, I take a hold position on Chesapeake before the concerns on the market stability eliminate and the company confirms its capacity to generate strong free cash flow.

Currently, Chesapeake’s PE ratio is 4.07, which is well below the oil and gas industry average of 13.75.

In the long term, CHK’s status as market major competitor and its assets portfolio of lucrative oil plays would help it surge as the global demand keeps growing and OPEC nations continue their limits on productions and exports.