Earnings Review: Higher Natural Gas Volumes, Derivative Gains Drive Chesapeake’s Top Line

Chesapeake Energy‘s (NYSE:CHK) released its third quarter earnings report on Wednesday, November 5. The company reported a 12% year-on-year rise in its earnings on the back of an 11% increase in production and an 8% reduction in capital expenditures. ^[1] Excluding one-time items, earnings per share came in at $0.38/share. Chesapeake reported a 17.2% increase in realized revenues, driven by a 47.6% increase in revenues from the sale of natural gas, oil and natural gas liquids and an 11% increase in revenues from marketing, gathering and compression activities. The company managed to increase its daily production by 11% to 726,000 barrels of oil equivalent(BOE) during the quarter; the increase was mostly driven by a 63% increase in the production of natural gas liquids. ((Chesapeake 10-Q, SEC)) The company increased its profit margin on production operations from 82.2% in the third quarter last year to 87.3% this year. Additionally, it also managed to lower its operating costs, completed the sale of several non-core assets and made several structural changes, such as the spin-off of subsidiary Chesapeake Oilfield to its stockholders, over the past few months. As a result, the company now finds itself in a very healthy position, both strategically and financially, in an environment with low commodity prices. Below, we take a closer look at some key factors affecting the company’s valuation.

See our complete analysis for Chesapeake Energy here

We have a $27 price estimate for Chesapeake Energy, which is about 20% above the current market price. We will be updating our price estimate for Chesapeake after the earnings release.

Natural Gas Liquids Drive Volumes Growth: In the third quarter of 2014, Chesapeake increased its overall production, adjusted for asset sales, by about 5% sequentially. ^[2] Total production for the quarter averaged 726,000 barrels of oil equivalent per day(boe/day), which represents an increase of 11% compared to last year. ^[3] Even though, the realized price of natural gas for the quarter, $2.67/Mcf, was nearly 33% lower than the average market price for natural gas over the period, it managed to achieve these results. However, the company will not be able to sustain this performance and natural gas prices will have to pick up in the future for a repeat of such results.

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1. Chesapeake 10-Q, SEC [↩]
2. Chesapeake Investor Relations [↩]
3. Chesapeake Investor Relations) While oil production and natural gas production were relatively flat for the quarter-oil production fell by 1%, while natural gas increased by 3%-natural gas liquids volumes drove the production growth, increasing by 63% year-on-year. ((Chesapeake Investor Relations) The company saw production rise at three of its most important asset locations: production in Eagle Ford increased by 12% sequentially, Haynesville increased by 11% sequentially and Utica Shale increased by 27% sequentially. As a result, the company revised its previous production guidance upwards to 700 million barrels of oil equivalent per day, representing an increase of 0.7%.

   Higher Realized Prices: In the previous quarter, Chesapeake Energy’s realized price for natural gas was between $0.92 and $2.32 lower than the Henry Hub benchmark price. Additionally, the company engages in a number of hedging strategies, such as a three way collar, which mean that it has to pay a lot cash if natural gas prices rise above a certain level. As a result of this, it suffered $210 million losses in derivative contracts in the previous quarter. In this quarter, the realized prices for oil and natural gas boosted the company’s revenues; oil sold at nearly 70% higher prices than in the third quarter in 2013 and natural gas prices were 17% higher. Moreover, it arranged its derivative contracts in such a way that realized gains from derivative contracts added an additional $622 million to the company’s top line, 26.5% of the company’s overall revenue for the quarter from the sale of commodities. ((Chesapeake Energy’s (CHK) CEO Doug Lawler on Q3 2014 Results – Earnings Call Transcript, Seeking Alpha, November 2014 [↩]