How Has The Commodity Downturn Impacted Chesapeake’s Leverage?

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The turbulence in the commodity downturn has weakened the financial position of a majority of the oil and gas companies across the globe. Due to depressed commodity prices, exploration and production (E&P) companies are finding it hard to sustain their declining profits, and in turn, their deteriorating cash flows. Such is the case with Chesapeake Energy (NYSE:CHK), the US-based exploration and production company, whose financial condition has diminished drastically over the last two years due to the oil slump. The independent company’s balance sheet has faded so much since mid-2014 that the company was on the rim of falling into the pit of bankruptcy earlier this year, when the oil prices reached their multi-year lows of under $30 per barrel. While the company has devised a four-point strategy to cope with the commodity trough, it is important to discuss how the company’s financial condition has changed over the last two years.

We begin with the debt-to-capital ratio, which indicates a company’s debt proportion in its total capital structure. Chesapeake’s debt-to-total capital ratio had trended at around 40% between 2010 and 2014, which implied that nearly half of its capital structure is made up of debt. However, due to the commodity downturn, the company suffered heavy losses over the last few quarters, which dragged down its cash flows. Consequently, Chesapeake’s shareholder equity deteriorated significantly, and stood at $229 million at end of the June quarter of 2016, as opposed to $18.2 billion at the end of 2014. Thus, despite the company’s efforts to repay and/or refinance its long-term obligations, its balance sheet has become highly leveraged.

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Secondly, we analyze Chesapeake’s Net Debt-to-EBITDAX ratio. This ratio indicates the number of years that a company would require to repay its long term debt (excluding cash and cash equivalents) at the current rate of profits. EBITDAX, which is the operating profit of a company before interest, taxes, depreciation, amortization, and exploration expenses, is a commonly used metric to analyze the oil and gas companies.

Due to plummeting cash flows, Chesapeake’s net debt has increased drastically over the last few quarters, causing a sharp rise in its Net Debt-to-EBITDAX ratio. An increase in this ratio implies that the company’s ability to meet its long-term debt obligations has deteriorated over time. However, Chesapeake’s Net-Debt-to-EBITDAX ratio has become negative in the second quarter of 2016, which means that the company has been making losses even at the EBITDAX level and it will be extremely difficult for it to meet its long-term debt obligations.

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Finally, we discuss the company’s interest coverage ratio. This ratio shows a company’s ability to fulfill its interest obligations. Since Chesapeake has losses at the EBITDAX level, it implies that the E&P’s ability to meet its interest obligations have also drooped notably, resulting in negative interest coverage ratio.

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Despite the company working hard to restructure its balance sheet by refinancing and/or reducing its long-term obligations, the weak commodity price environment has weighed heavily on its profitability and cash flows, making Chesapeake a source of investors’ anxiety.

Have more questions about Chesapeake Energy (NYSE:CHK)? See the links below:

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Chesapeake Energy

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