Fears Of Bankruptcy Cause Worried Investors To Penalize Chesapeake’s Stock

The onslaughter of the plummeting commodity prices has not ended yet. Oil and gas companies that were once flourishing due to the all-time high commodity prices are now struggling to survive the commodity down cycle. Chesapeake Energy (NYSE:CHK), the second largest natural gas producer in the US, is one such company that has been severely hit by the current downturn. Like a house of cards, the company’s stock has come down from almost $20 per share at the beginning of 2015, to its current price of less than $2 per share. Although the prevailing commodity prices have led to a notable decline in the company’s revenue as well as earnings over the last year, the company’s rising net debt levels have been the major cause of investor anxiety of late. Here, we discuss whether the market is panicking over nothing, or is Chesapeake really moving towards bankruptcy.

Chesapeake’s Debt Has Grown Much Faster Than Its Cash  

Since the summer of 2014, Chesapeake has been witnessing a steep drop in its price realizations due to the falling commodity prices. This has not only resulted in severe losses over the last few quarters, but has also reduced the company’s ability to generate sufficient cash flows to sustain its operations. Despite this, Chesapeake’s capital spending budget for 2015 was in the range of $3.4 to $3.9 billion, which is notably higher than its competitors. As a result, the independent gas producer’s long-term debt obligations have been rising steadily over time, even though its cash flows have been diminishing over the last few quarters. The company’s net debt has increased from $7.4 billion at the beginning of 2015 to $9.8 billion as of 30th September 2015. This clearly indicates that the company’s ability to service its long-term obligations has been deteriorating due to the challenging price environment.

Rating Downgrades And Maturing Obligations Has Created Panic Among Investors

Credit rating agencies, that have been downgrading a number of oil and gas companies in the current price scenario, have been quick to notice the higher leverage on Chesapeake’s balance sheet. As a result, Fitch downgraded the company’s debt from BB to BB- in the December quarter, a step further away from the investment grade rating. This caused risk-averse investors to worry about the financial solvency of the company, and prompted analysts to downgrade the rating of the company, revising their price estimates. This resulted in a large investor sell-off at the end of 2015.

Moreover, Standard & Poor’s (S&P) also downgraded Chesapeake’s corporate credit from ‘CCC+’ to ‘CCC’ with a negative outlook earlier this month. This further added to investors’ concerns over the company’s deteriorating financial condition. To add to this, the company has about $500 million of debt due for payment in March. Though the company does not have enough cash to service its obligation, it has access to a credit facility of almost $4 billion, which should be sufficient to pay back the debt. Yet, the investors grew skeptical about the company’s ability to weather the ongoing downturn.

See Our Complete Analysis For Chesapeake Energy Here

Company’s Attempts To Reassure Investors Have Backfired

Chesapeake has been proactively working to preserve its cash flows to remain afloat in the current depressed price environment. The company had suspended its common dividends last year to save the money for the tough times ahead. In January this year, the company further suspended its preferred dividends to save $170 million annually. However, the investors reacted negatively to the dividend cut, taking it as an indication of the company’s dwindling cash flows. Despite this, the company continued to restructure its debt by renegotiating better terms and longer maturities in order to control its interest costs.

In line with these efforts, Chesapeake recently announced that it was working with Kirkland & Ellis’ Advisers to restructure its long-term debt. Also, the company highlighted that it does not aim to pursue bankruptcy in the near future. Although the announcement was aimed at reassuring the market about the company’s fundamentals, it was viewed as a desperate attempt to improve the company’s perception in the market. The investors became further wary about the company’s weak financial position, resulting in an even worse sell-off last week. Chesapeake’s stock has dropped more than 55% since the beginning of 2016 and has been trading below $2 per share post the announcement.

 Source: Google Finance

What Do We Expect?

Keeping the aforementioned factors in mind, we believe that despite having high quality oil and gas assets that have the potential to generate a notable rate of return in a stronger oil price environment, Chesapeake is standing on the edge of a cliff. While the weak outlook for commodity markets has been creating a dent in the company’s earnings, its highly-levered balance sheet has also been weakening its perception among investors. In fact, the company’s repeated efforts to reinforce investor confidence have failed miserably, and have, in turn, instilled panic among risk-averse investors. Although the company has been fighting tooth and nail to survive the industry downturn, a challenging outlook for the commodity markets is pulling apart its efforts.

We expect the stock to further decline on the back of disappointing 2015 numbers and weak guidance for 2016, when the company announces its financial performance next week. Although with the negative market sentiment it might be difficult for Chesapeake to recover from this downturn, a steep recovery in commodity prices could push things more in the company’s favor.

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