3Q Earnings Review: Chesapeake Energy Reports An Earnings Surprise On The Back Of Its Cost Reduction Efforts

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As expected, Chesapeake Energy (NYSE:CHK), which reported its 2015 third quarter financial performance yesterday, reported a tough set of numbers largely due to the persistently low crude oil prices over the quarter [1]. The company’s lower price realizations pulled down its top line, while a one-time asset write down created a drag on the oil and gas company’s September quarter earnings. Yet, the US-based exploration and production (E&P) company managed to beat the consensus earnings estimate by 8 cents on the back of its cost control initiatives. Going forward, the company aims to reduce its operating costs further, and has reduced its capital expenditure budget for 2015. While the cost reduction initiatives are likely to dampen the effect of the downturn in oil prices, we expect Chesapeake to continue to experience a drop in its earnings at least for the next couple of quarters.

CHK-Oct price

Source: Google Finance

Lower Realizations Led To A Sharp Drop In Revenues

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Given the free fall of commodity prices over the last 15 months, a majority of the oil and gas majors have experienced a steep decline in their price realizations during this period. In the third quarter, the average benchmark crude oil prices (Brent) fell by more than 25%, leading to a  notable drop in Chesapeake’s price realizations. Further, the company’s overall production declined by almost 8% on a year-on-year basis, and by 4% on a sequential basis, due to the pull back in capital spending over the last few months. As a result, Chesapeake reported 3Q revenue of $2.9 billion, representing a reduction of close to 50% over the last year.

CHK-prod3Q

CHK-realizations3Q

Source: Chesapeake Energy Form 10-Q, 4th November 2015

Substantial Reduction In Operating Costs Result In An Earnings Surprise

In the present challenging oil price environment, all the large E&P companies have been trying to preserve their margins by controlling their operating and non-core costs. Along similar lines, Chesapeake Energy managed to reduce its production expense and general and administrative (G&A) expenses, both sequentially as well as annually. While the production expenses for the quarter fell 8.5%, the G&A expenses were down more than 11% compared to a year ago. However, the company posted an operating loss (GAAP) of $5.4 billion primarily because of a one-time impairment charge on its assets, which is driven by the deteriorating commodity markets. Thus, on an adjusted basis, Chesapeake reported a net loss of $0.05 per share, beating the market estimate of a loss $0.13 per share.

 

 

Outlook – Plans To Further Reduce Capital Spending

Due to the notable decline achieved from its cost cutting measures, Chesapeake expects its operating costs to decline further in the next quarter. Accordingly, the company has downwardly revised its production expense guidance to $4.25-$4.50 per BOE from its previous guidance of $4.40-$4.90 per BOE for the full year. It has also revised its G&A expense target to $0.70-$0.80 per BOE, which is almost $0.50 per BOE lower than its prior expectations. These reduced costs are likely to ease some of the pressure on the company’s bottom line.

While the company’s cost reduction efforts are bearing fruit, the outlook for the commodity markets remains uncertain. Consequently, the company has decided to further restrict its capital spending in the December quarter to meet its new capex guidance of $3-$3.5 billion for the full year 2015. In addition, the company also hinted at further spending cuts in 2016. However, Chesapeake continues to have a strong target for its production growth for 2015. The company aims to grow its production in the range of 6-8%, despite the lower price realizations.

CHK-guidance2015

Source: Chesapeake Energy Form 10-Q, 4th November 2015

Thus, we conclude that while Chesapeake’s cost control initiatives may dampen the effect of sluggish commodity prices, they might not be sufficient to remove the pain of the current downturn. Consequently, we foresee further contraction in the company’s earnings in the coming quarters, if the commodity markets do not recover soon.

See Our Complete Analysis For Chesapeake Energy Here

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Notes:
  1. Chesapeake Energy Announces 3Q Results, 4th November 2015 []