Chesapeake Energy’s 3Q’16 Earnings To Improve Due To Recovery In Commodity Prices

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Chesapeake Energy

Chesapeake Energy (NYSE:CHK), one of the largest natural gas producers in the US, is expected to release its September quarter financial results on 3rd November 2016. Unlike the last quarter, the market hopes to see an improvement in the company’s third quarter performance on the back of the rebound in commodity prices, and strong progress made by the company’s strategy to weather the current down cycle.

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While the commodity prices continued to be much lower compared to the last year, natural gas prices showed early signs of recovery in the quarter. Henry Hub natural gas prices, a global benchmark for gas prices, increased almost 35% in the third quarter, while crude oil prices remained flat during the same period. The improvement in price realizations is likely to result in a sizeable recovery in Chesapeake’s top line for the third quarter. However, the revenue will remain depressed on an annual basis, as the commodity prices have not recovered completely.

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On the cost side, Chesapeake has a plan to reduce its lease operating expense (LOE) and general and administrative (G&A) expense by 10% and 15%, respectively, during the year to sustain its operating margins. In the first half of the year, the company had managed to bring down its cash costs by roughly 26% compared to the same period in 2015. Thus, we expect the company’s costs to reduce further in this quarter, resulting in an improvement in its operating income and margin.

On the liquidity front, Chesapeake has cut its capital budget by more than 50% for this year in order to preserve its depleting cash flows. Consequently, the company expects to spend $1.26-$1.76 billion on its exploration and drilling activities for the full year 2016. So far in the year, the company had restricted its capital spending by 60% compared to the last year. In order to fund its capital budget, the company had completed asset sales of $1 billion and is expected to generate more than $2 billion in asset divestitures by the end of the year.

Further, the second largest natural gas producer made significant headway in improving its capital structure during the quarter. In this quest, Chesapeake issued new unsecured convertible notes of $1.25 billion, with a provisional call feature that will allow the company to convert the debt into equity within three years, subject to certain conditions. Further, the company reduced $1.2 billion of its preferred stock at a discount of over 40% in October. The two transactions will together result in additional liquidity and less preferred equity for Chesapeake, which will be immediately accretive to its capital structure.

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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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