Chesapeake Energy (NYSE:CHK) earlier in the year took a pounding due to falling gas prices. It has since then recovered considerably as it increasingly moved away from its dry gas business. We have a $21 price estimate for Chesapeake, which is governed primarily by two factors – its growing oil & NGL production and its receding gas production. Let’s see how these factors affects the company’s value.
Chesapeake’s $21 price estimate is nearly 10% above the current market price.
Oil & NGL Production Business
Chesapeake Energy had earlier planned to increase its liquids production by 25% per year and it has been largely successful in doing so. At current levels of natural gas prices, it is unreasonable to place too much emphasis on its gas business. The renewed strategy is to focus on oil exploration and this has been fruitful for the company as reflected by its improved Q2 results. This also had a significant contribution in uplifting the stock price, which slumped to below $14 in May, 2012.
It is generally difficult to specifically raise the liquids output considering that the output profile of a well keeps fluctuating wildly. Hence, the company’s drilling capabilities are to be appreciated that despite there factors it raised the oil output. We believe that the company will now be far more flexible in meeting the demand based on market conditions. Further, the company has significant positions in all shale formations in the U.S., some of which are rich in liquids, such as Utica shale formation in Ohio. It is aggressively drilling wells in the Utica shale. Hence, given the company’s prowess in drilling oil, we believe it should be able to meet its ambitious oil production plans fairly comfortably going forward.
Oil prices fell earlier in the year, but they have recovered some, which bodes well with the company’s operations. On the contrary, the NGL prices are highly correlated to the gas prices since NGL is produced in conjunction with gas, though there are other minor factors too deciding the price of NGL. NGL prices fell last year but with expected higher future gas prices, we expect NGL prices to rise also.
This division contributes nearly 57% value to the company’s stock. Hence it is critical for the company’s performance.
Natural Gas Production Business
Chesapeake has been closing several gas wells because it was unprofitable to run those wells at current gas prices. That’s why in the near-term the company’s gas output is likely to shrink. However, the same wells that have been stalled will be put to operation once it is plausible to run those well, which is driven by gas price. Hence, the most dominating trend for this division is the price of natural gas. We expect the gas prices to rise considerably in the near-term since there has been a rally in prices in the last few months. However, in the long-term, we expect its growth to be gradual.
Generally, higher gas price has been followed by higher gas output, though with a lag. In our estimates we have incorporated that trend. So, we believe in the near-term, while gas prices keep recovering, Chesapeake will keep reducing its gas output. After there is a significant reversal in prices, the wells will be again put to operations. Hence, we expect the gas output to rise 2013 onwards following the recovery in gas price in 2012-13.
Presently, a major concern for Chesapeake is its large debt that stands at $14.3 billion. It plans to execute sales of several of its assets to fund its capital expenditure and reduce debt. Looking at the company’s historical track record in selling assets, we are fairly confident that the company will be able to bring down the debt level and unlock value. In recent days, the company raised its projection for 2012 asset sales to $14 billion.