Chesapeake’s Assets Sales Give It A Breather, But Not For Long

Chesapeake Energy (NYSE:CHK) has some room to breath as it has struck a deal to sell its Permian assets in west Texas for nearly $3.3 billion. Putting this sale together with its recently announced sale of its pipeline business and some non-core assets in the Utica and Woodbine for $3.6 billion, the total asset sale would be close to $6.9 billion. ^[1] With these deals, the company is on track to meet this year’s target of $14 billion as assets sales now total more than $11.5 billion for the year.

While the sale may provide a short term relief, one has to be cautious about the company’s long term prospects. Below we discuss why we think so?

See our complete analysis for Chesapeake

Chesapeake is no longer the high flyer it once was as the circumstances look more difficult for the gas driller each day. The company was severely hit by falling natural gas prices in the last few months. Natural gas prices are hovering close to their 10 year lows. This coupled with huge capital expenditure have adversely impacted the operating cash flows of the company leaving the company with huge debt. The company had no other option but to aggressively pursue asset monetization in order to meet planned capital expenditures and reduce the company’s significant debt burden to avoid a default.

While the company received much less than it was expecting ($3.3 billion for Permian assets against $6 billion expectations), the assets sale will eventually help the company repay a $4 billion additional short term debt at 8.5% interest rate. Failing which, the interest rate would have been changed to 11%, making things difficult for the cash strapped company. The sale will also lead to a reduction in the company’s total debt exposure to $9.5 billion by the end of the year from current $14 billion.

However, the long-term outlook still remains dubious unless natural gas prices rebound quickly. For the same reasons, the stock didn’t react much to the news. Natural gas still constitutes a significant chuck of the company’s total reserves. Without higher prices, the company may not be able to fund the complete $7 billion or more it is planning to spend on drilling next year, and asset sales and new debt may no longer remain a viable option.

While assets sale generate cash, they also result into loss of reserves and low production. This means, lower revenues going forward. The recent moves won’t make sense unless the company reduce operating expenses much faster than revenue. Further, a heavy capital expenditure plan coupled with a large debt load is not an ideal situation to be in, and persistently low natural gas prices may also lead to another credit rating downgrade. With low gas prices and another potential downgrade would make loans even more costlier as well as for restructured loans if that happens. To revive the company’s fortune, higher natural gas would be the best way for the company to get back into a better position, and so far now, it seems the company is at the mercy of volatile gas prices.

We currently have a $21 price estimate for Chesapeake, 5% premium to the current market price. We are in process of revising our price estimate to reflect these deals. The assets sold currently produce 90 million cubic feet per day of natural gas and 21,000 barrels per day of liquids (approximately 5% of the company’s production). As most of the assets sold were natural gas blocks, it confirms the company’s strategy to bet more on liquids drilling than natural gas. Read the discussion here why, this could help the company in long term.

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1. CHESAPEAKE ENERGY CORPORATION ANNOUNCES AGREEMENTS TO SELL PERMIAN, MIDSTREAM AND CERTAIN OTHER ASSETS FOR TOTAL NET CASH PROCEEDS OF APPROXIMATELY $6.9 BILLION, Chesapeake Press Release, Sept 12 2012 [↩]