Chesapeake Preview: Liquids Production And Asset Sales In Focus

by Trefis Team
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Quick take

  • Chesapeake reports Q4 2012 earnings on February 21.
  • Stock has been weighed down by low natural gas prices, a high debt load and corporate governance issues.
  • Focusing on oil production to offset some natural gas woes. Volumes have doubled during the first nine months.
  • Winter demand and a shifting preference for natural gas in power generation could drive gas volumes.
  • Debt of around $16 billion, typically weak cash flows. Progress of asset sales will be critical.

Chesapeake Energy (NYSE:CHK), America’s second largest natural gas producer, is expected to release its Q4 earnings on February 21. Over the past year, the firm’s stock has been impacted by low gas prices, corporate governance issues and concerns about the company’s mounting debt. However, in recent weeks the stock has seen a slight recovery following news that the firm’s beleaguered CEO Aubrey McClendon would resign.

In the third quarter, the firm had posted a 25% decline in revenues due to low natural gas prices while the operating loss stood at around $3.1 billion due to write-downs relating to its natural gas assets. ((Form 10-Q)) For this quarter, we expect the firm to report better revenues and earnings, thanks to relatively stable natural gas prices and the firm’s focus on liquids production. Here are some of the key numbers and trends that we will be watching when the firm releases earnings Thursday.

Progress Of The Natural Gas Business

Natural gas prices have stabilized at just above the $3 level over the last few months, recovering from lows of under $2 in early 2012. Although gas prices are still well below their historical levels, they are attracting more consumers towards the fuel. The electric utility sector has been progressively substituting coal fired power plants with gas due to its lower generation costs and a better environmental profile. Industrial demand for gas is also expected to see growth going forward as low prices are attracting manufacturers to relocate plants into the country. Industrial consumption accounts for about 27% of total U.S. gas consumption, and an increase in this demand could boost overall natural gas volumes. These factors should help gas prices and demand to pick up into the future.

Liquids Production Volumes

Chesapeake has sharply increased its liquids production over the last year in an attempt to de-risk its revenue stream away from volatile natural gas prices. While U.S. natural gas prices are dependent purely on demand from the North American market, liquids prices are largely driven by global oil prices (natural gas liquids are to an extent dependent on natural gas prices), which have been relatively stable.

The firm has nearly doubled its oil production during the first nine-months of the year while natural gas liquids (NGL) production was also up by almost 30% compared to 2012. This growth is commendable given that it is generally difficult to raise the liquids output considering that the output profile of a well can fluctuate widely. The firm has been beefing up its drilling activity, and this should contribute to a further increase in liquids production going forward.

Asset Sales And Debt Reduction

While Chesapeake holds some of America’s largest onshore natural gas and oil reserves and the assets required to harness them, most of the asset growth has been funded by debt. The firm’s long term debt has risen to nearly $16 billion as of Q3 2012, up from just over $10 billion in 2011. Given the firm’s lack of financial flexibility, we believe that a turnaround will hinge on its ability to monetize assets at fair prices and curb capital spending. Over the last year, the firm has divested several assets including its midstream business and a large portion of its Permian basin acreage, raising a total of around $11 billion. But given the prevailing conditions in the natural gas market, price realization has been weak. We will be watching the firm’s plans to cut debt and further monetize its assets going forward.

We have a price estimate of around $21 for Chesapeake Energy, which is in line with the current market price.

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