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Chesapeake Calms Investor Fears

Posted: Oct 22, 2008 11:19 AM by Eric Fox

Tickers in this Article: DB, BCS, HK, SWN, LEHMQ, CHK

Management at Chesapeake Energy (NYSE:CHK) addressed several topics of concern to investors during the company's recent two-day analyst meeting in Oklahoma City. The company seems ready for a sustained downturn in natural gas prices.

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Chesapeake Energy is one of the largest producers of natural gas in North America, with 3.5% of total production and 12.1 trillion cubic feet of natural gas equivalent (tcfe) of reserves. The stock has been one of the worst hit during the recent selloff in the energy sector. Investors dumped shares indiscriminately due to the sharp fall in prices for oil and gas and because of concern that the industry would have its access to capital restricted as a result of the financial crisis. The stock peaked at $73.85 in July 2008 and recently traded at a 52-week low of $11.99 on October 10, 2008, before closing at $16.52.

Cash Flow
Some investors were concerned that Chesapeake Energy's cash flow would fall short of the amount needed to service its debt or maintain its debt covenants. However, the company appears to be hedged for 2009 and 2010 to help protect against an even further drop in natural gas prices. Sixty-nine percent of 2009 production is hedged at an average price of $9.56 per thousand cubic feet of natural gas equivalent (mcfe), and 42% of 2010 production is hedged at $9.81 per mcfe. The company projects that even at a natural gas price of $6.00 per mcfe, the company still would produce positive operating cash flows and remain in compliance with its covenants for 2009 and 2010.

In addition, Chesapeake Energy currently operates in full compliance with its debt covenants for its bank credit facility, which includes maintaining a consolidated-indebtedness-to-consolidated-total-capitalization of less than 0.70, and sustaining a consolidated-indebtedness-to-EBITDA of less than 3.75. The ratios at September 30, 2008 were 0.59 and 2.19, respectively.

Another concern had been counterparty risk, which refers to the ability of another financial institution with a contractual relationship to Chesapeake Energy to adhere to that contract. This concern had increased since the bankruptcy of Lehman Brothers (OTC:LEHMQ). Chesapeake Energy appears to have a diversified list of counterparties, however, which should minimize risk in this area. At present, Chesapeake Energy's two largest counterparties receivable are Barclays plc (NYSE:BCS) and Deutsche Bank (NYSE:DB).

The company also has flexibility on capital expenditures should it need to conserve more. Over the last month, Chesapeake Energy has cut future capital expenditures over the next few years by $5.1 billion. Drilling CAPEX was reduced by $3.7 billion, or 20%, and Property CAPEX was cut by $1.4 billion, or 16%.

In addition, the company said that its planned sale of non-core assets is on track. Chesapeake Energy is selling assets in Oklahoma and South Texas as well as taking on partners in its acreage in the Marcellus Shale and in its midstream business. These sales will raise between $3 billion and $4.5 billion in cash.

Asset Portfolio
Chesapeake Energy highlighted its large portfolio of properties. The company soon will have 135 rigs drilling, down from 145 at present. In addition, it has over 37,000 future drilling locations, or a ten-year inventory. Chesapeake Energy's largest area of play is in the Marcellus Shale, where it has 1.7 million acres under lease.

Other oil and gas exploration companies with large acreage in natural gas plays are Petrohawk Energy (NYSE:HK), with 300,000 acres in the Haynesville Shale, and Southwestern Energy (NYSE:SWN), with 857,000 acres in the Fayetteville Shale in Arkansas.

Chesapeake Energy management at the recent analyst meeting seemed to assuage investors' concerns over the state of the company's finances.

By Eric Fox

Eric J. Fox, is the founder of Brittain Capital Management, LLC., which manages the Alesia Fund, LP., a Value oriented long/short investment partnership. You can read more of his views on investments at his blog - Stock Market Prognosticator. Mr. Fox also publishes a paid investment newsletter. Please visit The Unknown Stock Report for more details.

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