Can Chesapeake really be a good value? It sure seems so based on the large amount of recent insider buying. This is all the more notable since insiders are not buying much of anything in this elevated market. I’ve been doing this long enough to know that when insiders are buying and you can’t see the logic, don’t doubt it. There is always something there. You might not be able to see it, but that doesn’t mean the catalyst isn’t there. It also doesn’t mean that it will ever come to bear either so you can’t be stupid about blindly following insiders. In an effort to probe a bit deeper, I wanted to update our proprietary check list. In the past Chesapeake has not scored well. And I personally swore off investing in the Company while Aubrey McClendon was the CEO. Now that he’s gone, I’m taking a closer look.
A recent article from the New York Times dates July 3rd, Chesapeake Discover the Price of Costly Quest for Oil does little to dispel the gloom about the stock. It states that “Chesapeake is offloading another $1 billion of assets. It needs cash because even though it has found more crude in the United States in recent years than any rival, including Exxon Mobil, it spent too much to do so. The company’s founder, Aubrey McClendon, may be gone, but his painful legacy lingers.”
What I didn’t know is that “Chesapeake, based in Oklahoma, added 705 million barrels of oil from the United States to reserves the last two years, making it the nation’s most successful explorer, according to research by consultancy IHS. In 2012 alone, the company uncovered twice as much oil as Chevron, whose $230 billion market value is more than 16 times higher than Chesapeake’s.” The article goes on to say that they paid more per barrel than competitors EOG Resources or Continental Resources. What they don’t say though is that already discounted in the stock price.
One thing though you will never hear anyone say, is that Chesapeake doesn’t toot its own horn. The Company has aggressively touted its investment merits to a fault. This latest presentation is no exception.
CHART- know how to read charts. I firmly believe I can improve the price of buying or selling from an understanding of chart action. The Chesapeake’s stock chart looks like it’s building a solid base and will go higher from here. On that factor I score it +1
ANALYSTS- read analyst reports but come to your own conclusions. The street is negative on Chesapeake. There are only 9 buys with 24 holds and sells. I score that a +1. I’m a contrarian. If everyone loves the stock, who’s left to buy it?
INSIDERS- if the people that know the company the best are not buying it, why should you? +1
This is an extract from the Washington Service., the source we use to track insider buying.
| CHK Director Buys $3 Million |
| June 26, 2013 |
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Chesapeake Energy Corp. (CHK) Director Frederic M. Poses purchased 152,632 shares on 6/21/13. The $3.0 million buy was his second since joining the board of directors in June 2012, and it increased his holdings by over 28%. Poses purchased at $19.87, just over 13% below CHK’s 52-week high in mid-March. As shown on the graph below, Poses’s one previous buy in CHK was well-timed. His $4.5 million buy in mid-November, described in an article published 11/15/12, preceded a increase of nearly 24% in the following six months. He has also done well buying at TE Connectivity Ltd. (TEL) and Trane Inc. (formerly TT), where his nine purchases yielded an average annual return of 16.8%.
Insider buying at CHK was last highlighted in a 5/22 article describing Director Archie W. Dunham’s 450,000-share purchase. Since then, Directors Thomas L. Ryan and Louis A. Raspino have also joined in purchasing the oil and natural gas producer. Ryan purchased a total of 7,000 shares for $149.5K between 5/21-6/11, while Raspino spent $525.5K buying 25,000 shares on 5/20-5/21.
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MANAGEMENT DISCUSSION 10Q AND 10K- this is the only truthful thing you will read about a company. It’s composed by management, the auditors, and the firm’s lawyers. If all three of them can agree on the verbiage, it’s passed a big hurdle. Read it carefully. Pay particular attention to the Risks, Litigation, and Related Transaction sections. These are the things you will wish you had taken the time to read if something goes bad with your investment. Even before Carl Icahn and activist investors threw out Aubrey McClendon, the CEO had been shifting Chesapeake to higher return liquids from dry gas. Now there is new management at the Company. They ejected ole’ Aubrey. If there was a more slippery CEO out there, I don’t know about it. On May 19, 2013, Chesapeake Energy Corporation (the “Company”) and Robert Douglas (“Doug”) Lawler entered into an employment agreement pursuant to which Mr. Lawler will join the Company as President and Chief Executive Officer and a member of the Board of Directors on the Effective Date (as defined below). Mr. Lawler, age 46, was previously employed for 25 years by Anadarko Petroleum Corporation (NYSE:APC) and Kerr-McGee Corporation, where he served in multiple engineering and leadership positions within a diverse geographic portfolio including U.S. onshore, deepwater Gulf of Mexico and international assets. Merrill Lynch calls him a ‘rising star’ and goes on to write “and in our view most likely to succeed Al Walker as COO had that position been reinstated. Having recently moved from an operating role running APC’s onshore assets that substantially overlap with CHK, he was most recently Snr VP of Int’l & Deepwater operations, and a member of the Exec Committee. Overall we believe his strong operating background underlines the shift to development underway at CHK. With interim CEO Dixon reinstated as COO & CFO Dell’Osso both locked in for 3 yrs continuity should not be an issue.”
That’s a big positive +1
RELATIVE PERFORMANCE- If the stock has a superior relative performance to the market in the short term . CHK has underperformed the market by 3.69% over the last four weeks. -1
SECTOR OUTLOOK- buying a good stock in a bad sector can be a humbling experience. Oil and Gas has been neutral YTD 0
CASH FLOW- cash flow is more accurate than earnings. Earnings can be more easily manipulated. CHK has cash flow way in excess of earnings. +1
PEG RATIO- it’s good to find a company growing faster than it’s multiple. Reuters has it at five year .27 which is great. +1
VALUATION- contrary to popular opinion, it does matter what you pay for a company. Check its discounted cash flow value. Buy it for less than what it’s worth, a 1, less a -1, about the same 0. JP Morgan analyst has a $20 target valuation. Merrill Lynch has a $36 price target . Morningstar analyst write “We are increasing our fair value estimate for Chesapeake from $26 to $31 after incorporating the firm’s most recent results, management’s latest guidance, and current oil and gas strip prices. Our new fair value estimate implies a forward 2014 enterprise value/EBITDAX multiple of 5.5 times, and is based on our five-year discounted cash flow model and an assessment of trading multiples, comparable transactions, and longer-term resource potential.We project average daily net production of 4.0 Bcfe in 2013, 4.5 Bcfe in 2014, and 5.0 Bcfe in 2015, representing a 9% compound annual growth rate over 2012 levels” while the JPM analyst writes
“For CHK, the Era of Reckless Spending is over, in our view. But the market likely now knows that Chesapeake will be a more disciplined company in the future. Stock price performance relative to its peers probably relies on the result of asset sales as much as anything else. And we have no visibility on the company executing better- than-expected asset sales.Although CHK has managed to reduce spending and costs successfully, we model the company outspending cash flow in 2013, 2014, and 2015. We believe its planned asset sales will help CHK fund its cash outspend in 2013 but CHK has another funding gap in 2014 and 2015, according to our model.We think the stock is relatively fairly valued. Our Neutral rating reflects valuation, lack of visible catalysts and the company’s persistent funding gap.”
Two firms think it’s fairly valued and two think its undervalued. I give it a 0 because it’s unclear to me who is right although I’m inclined to go with the insiders on this one.
CATALYST- what’s going to change the status quo? Chesapeake has a lot of debt, nearly $13 billion in all. According to JP Morgan May 15th analyst report they have a $9.3 billion cumulative funding gap through 2015 yet in the Company’s latest presentation they state that total capex is $7.6 billion for 2013. I’ll have to get more feedback from the Company but on July 2nd, they sold a $1 billion dollar chunk of production to Exco. Including Wednesday’s deal, their asset divesture stands at about $3.6 billion, enabling it to fully fund its capital expenditure budget of $7.6 billion for the year, Chesapeake Chief Executive Doug Lawler said. Sterne Agee & Leach analyst Tim Rezvan said the sale does not eat into Chesapeake’s production stream as the assets represent about 4 percent of the company’s first-quarter output.
Chesapeake is the 2nd largest producer of natural gas in the U.S. yet in 2012 and 2013, their CAPEX is 84% and 86% liquids. Although revenue is essentially flat CHK is projected to grow their earnings by 50% in 2014, 282% in YOY. They expected to increase EBITDA by 31%, grow oil production by 22%, decrease capex by 43%,and decrease net wells to sales by 14%, an operating efficiency ratio. Chesapeake has been selling assets to reduce debt but claims that it’s drill bit production is outpacing asset sales. If that happens this will definitely pop the stock. Right now there is a credibility problem left over from Aubrey McClendon. With Carl Icahn and Southeastern owning nearly 22% of the Company, I don’t expect management to sit around and draw a tidy paycheck without increasing shareholder value. +1
The bottom line is, Chesapeake is much more promising than I thought. It scores a 6 out of 10.