What Caused Chesapeake’s Stock To Plunge So Drastically?

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Chesapeake Energy

This year – 2015 – has been a bad year for the oil and gas industry, as commodity prices touched multi-year lows, digging a hole in the pockets of some oil and gas majors, while making it extremely hard for the others to sustain their businesses. One such company is Chesapeake Energy (NYSE:CHK), the second largest natural gas producer in the US, which has had a tough year due to the plummeting natural gas prices. Interestingly, the company’s stock experienced an 80% drop since the beginning of the year, though the Henry Hub natural gas prices plunged only about 32% during the same period. Thus, we think that there is more to the company’s disappointing performance than just the depressed gas prices. In this article, we discuss the factors that have caused a downfall in the company’s performance over the last month.

CHK-HH

Source: Google Finance; US Energy Information Administration (EIA)

Commodity Prices Fall Below Chesapeake’s Break-even Prices

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At a time when the majority of the oil and gas producers were pulling back their upstream spending and/or restricting their production to withstand lower price realizations, Chesapeake revised its production target to 670,000-680,000 barrels of oil equivalent per day (BOE/d) from 645,000-655,000 (its guidance at the beginning of the year) on the back of the superior drilling results from its high quality assets and remarkable reduction in its operational costs. To weather the current downturn, the natural gas driller has been focused at improving the recovery rates of its existing wells and reducing the drilling costs of its onshore plays. Due to its consistent efforts, the company has managed to deliver a significant reduction in its production cost over the last one year, bringing down its break-even costs to around $2.50 per Mcf for its natural gas assets, and to less than $50 per barrel for its oil assets.

CHK-breakeven

Source: Chesapeake’s 3Q15 Presentation

While the enhanced recovery techniques allowed the company to produce more at a lower cost, the increased production added to the already over-saturated commodity market (Also read: Why Is Chesapeake Boosting Production Despite Low Oil Prices?). Although, the company’s increased volumes did not trigger much volatility in the commodity markets, there were a host of other events that took place over the last month or so that have washed out the little recovery in the commodity prices during the last quarter. These events include OPEC’s decision to refrain from setting production quotas and continue producing oil at record high levels, Iran reaffirming its plans to boost oil production as soon as the international sanctions are lifted (early 2016), and milder-than-expected winters in the Eastern US further reducing the demand for oil and natural gas. As a result of these events, the global benchmark for crude oil prices – Brent – reached under $40 per barrel, while Henry Hub natural gas prices have touched sub-$2 per Mcf levels over the last few days.

 

As the commodity prices fell below Chesapeake’s break-even prices, it triggered a wave of insecurity among investors who feared that the company’s incessant production in a challenging price environment could further worsen the existing glut in the global markets. Additionally, since the markets have a pessimistic outlook for the commodity prices at least for the next few quarters, Chesapeake’s financial position is not expected to recover anytime soon. Hence, the company had to suffer due to the investors’ risk averse nature, which led to a drop of more than 36% in its stock price over the last one month.

See Our Complete Analysis For Chesapeake Energy Here

Weak Balance Sheet Due To Lower Net Debt Position

Despite improved production results from its key plays, Chesapeake has been witnessing a sharp drop in its price realizations over the last few quarters. This has led to severe losses over the last three to four quarters, creating a dent in the company’s ability to generate sufficient cash flows to sustain its operations. Further, the company has a capital spending target in the range of $3.4 to $3.9 billion for the full year 2015, even when the rest of the industry has been holding back their spending budget. Moreover, the independent gas producer’s long-term debt obligations have been steadily increasing, while its cash flows have been dwindling over the last few quarters. As of 30th September 2015, Chesapeake had $1.7 billion in cash and cash equivalent as opposed to a long-term debt (including short term debt) of more than $11.5 billion. Thus, we infer that in the prevailing scenario, the company does not have enough cash to service its debt obligations, although the company has high quality oil and gas assets to generate a notable rate of return in a stronger oil price environment.

CHK-Net debt

Source: Company filings

The fact that Chesapeake is highly-levered has been noticed by the rating agencies too, which is why Fitch downgraded the company’s debt from BB to BB-, which is one more step below investment grade. As a result, the investors became further wary of the company’s financial solvency. This resulted in a series of rating downgrades by a number of analysts and a steep drop in the value of the company’s bonds over the last month. In response, earlier this month, the US-based gas driller has offered to exchange its outstanding senior unsecured notes of varying maturities for 8% new, secured second lien notes due in 2022. While the move was aimed at easing the heat about the company’s fundamentals, it has only aggravated the situation. The investors have viewed this as a desperate attempt to improve the company’s perception in the market, and have in turn penalized the stock. The stock is currently trading at $4 per share, which is the lowest that the company has touched in the last decade.

CHK-Dec

Source: Google Finance

Based on the aforementioned trends and market perception, we have revised our price estimate for Chesapeake Energy to $8 per share. However, in the light of the volatile commodity market and unforeseen global events, we will revisit our estimate based on the company’s full year 2015 numbers and 2016 guidance, expected to be out in a month’s time.

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