Chesapeake Energy – Quantifying the Impact of Production Costs on Stock Value

Founded in 1989, Chesapeake Energy (NYSE:CHK) has grown to become the second largest producer of natural gas and one of the most active drillers of new wells in the US. The company’s operations are focused on discovering and developing unconventional natural gas and oil fields onshore in the US. Chesapeake competes with other oil and gas producers like Exxon (NYSE:XOM), ConocoPhillips (NYSE:COP), Anadarko (NYSE:APC), BP (NYSE:BP) and Chevron (NYSE:CVX).

We maintain a price estimate for Chesapeake at $25.01, roughly 7% ahead of current market value.

Chesapeake Maintains Low Production Costs Relative to Competitors

Despite historically low levels of natural gas prices, Chesapeake Energy’s operating cash flow has remained positive. The company has been able to keep its average production costs low. Between 2007 and 2009,  average production cost for Chesapeake was only $0.97 per million cubic feet equivalent (mcfe) of natural gas.

These figures were much higher for some of Chesapeake’s competitors, such as $1.15 per mcfe for BP, $1.61 per mcfe for Chevron, $1.3 per mcfe for Conoco Phillips, $1.33 per mcfe for ExxonMobil, and $1.47 per mcfe for Anadarko. The average for these competitors is $1.37 per mcfe, much higher than Chesapeake’s $0.97 per mcfe.

Currently, we project that Chesapeake’s EBITDA margin for natural gas will breach 80% by 2017 and close in on pre-recession levels of around 85%.

A Rise in Production Costs Would Hinder Profit Margins and Stock Value

However, if the average production cost for Chesapeake, which was $0.97 per mcfe in 2009, increases towards the $1.37 per mcfe level described above (the average of the competitors listed), it would create significant downside to the company’s natural gas production EBITDA margins and, ultimately, its stock value.

If Chesapeake’s EBITDA margin for natural gas illustrates a more modest increase in the years ahead than our base estimates, to only 70% by the end of our forecast period, it would generate 37% downside to the company’s intrinsic stock value.

Drag the trend-line in the chart above to see the affect of various EBITDA margin scenarios on the company’s stock value.

The above analysis reveals the sensitivity of Chesapeake’s stock value to changes in its natural gas production operations. Given the importance of this segment to the company’s overall profitability and value, we pose the following question…

What Percentage of Chesapeake Energy’s Stock Value Stems from Natural Gas Production?

Make a selection below to see the answer…

A.  55%

B.  65%

C.  75%

D.  85%

See our full analysis of Chesapeake Energy here