Chesapeake Energy (NYSE:CHK) has had an incredibly bad run over the past few years. The company has engaged in various strategic errors, had several unfortunate developments occur operationally, and has now gotten pulverized with the further collapse of energy prices. The price of CHK stock is down to just 18 cents after trading around $5 just a few years ago.
Even at 18 cents, there’s plenty of downside left to go. In fact, there’s a good chance that Chesapeake stock will ultimately end up worthless.
As it stands, the company has more than $9 billion in debt and was consistently losing money even when energy prices were much higher than they are today.
Now, with Saudi Arabia launching a price war for oil, energy prices have completely collapsed. And then there’s the coronavirus mess on top on that. Chesapeake was already struggling to remain a going concern when oil was $50/barrel three months ago. The situation is far worse as oil has lost half its value since then. Here’s how things went wrong for Chesapeake Energy.
A Misguided Switch to Oil
For many years, Chesapeake was one of the key players in the emerging American natural gas industry. It was a pioneer in finding and exploiting new natural gas fields, and made a ton of money getting claims on the best pieces of land early. While the company’s strategy initially showed great promise, fortunes quickly turned. After the financial crisis, the price of natural gas slumped, making most of this exploration activity unprofitable.
As a result, Chesapeake pivoted away from natural gas and toward oil. At the time the business strategy made sense. The price of oil was still relatively high, even as natural gas had fallen to multi-year lows. However, by the time Chesapeake had fully reoriented its business (at great expense) into oil, the roof caved in.
Oil crashed to $50/barrel recently, and then things went from bad to worse. Earlier this month, Saudi Arabia announced an open price war on the price of oil. It is, apparently, aiming to punish Russia and the U.S. for producing too much oil.
In any case, the price of oil slumped as much as 50% after their announcement, falling to levels last seen regularly more than 15 years ago. Chesapeake already had the thinnest of margins for error when oil was $50 per barrel. At today’s $25 price, the company will struggle to remain solvent.
Most Endangered
A Bloomberg article from earlier this month called out the five shale producers most likely to go bankrupt. Its first selection? Chesapeake Energy.
It noted that Chesapeake had long been struggling before the coronavirus and energy price wars kicked off. The rise of the Permian shale has flooded the market with both oil and associated gas, driving down prices and making Chesapeake unable to generate sufficient cash flow.
Meanwhile the company’s debt is a massive problem. Yes, the company completed its debt swap recently, pushing off some debt that would have been due in August. But that was only $192 million of debt that the company took care of, meanwhile it has a total debt load of more than $9 billion. And its plan to do asset sales to raise money are likely to flop. Just look at the dreadful market for energy right now. Who would pay a fair price for Chesapeake’s assets?
Balance Sheet Worries and CHK Stock
Late last year, Chesapeake had appeared to solve some of these problems. Or, at a minimum, at least kick the can down the road for a while. The company proactively engaged in a debt swap that greatly lightened its near-term obligations. On top of that, Chesapeake successfully hedged the majority of its oil production for 2020 up at reasonable prices back when oil was still in the $50s.
As a result, Chesapeake – though still in a deeply-troubled long-term state – at least had a fighting shot through 2021. Now, though, the utter and complete collapse of oil and gas prices has Chesapeake in grave danger.
Bulls point to cost-cutting to try to keep hopes alive. But Chesapeake has already cut costs to the bone. And remember that production from fracking tends to decline at a rapid rate; once you stop spending enough on capital expenditures, your production rates plummet. Chesapeake may be able to wiggle its way through 2020 without running out of cash, but it will be in a most difficult state next year as the hedges roll off and its production levels slip.
CHK Stock Verdict
I know it’s tempting to look at a stock trading at 18 cents and think that it must be cheap. Particularly a company like Chesapeake that is well-known within its industry. Surely with its brand and history, this must be a decent speculative play down here, right?
No, not at all. Given the vast amounts of shareholder dilution over the years, Chesapeake now has a stunning 1.9 billion shares of stock out there in circulation. As a result, the stock market is still valuing Chesapeake at a $400 million market capitalization. That’s a ton of money for a company in as dire a position as Chesapeake. Normally, a company this close to potential bankruptcy filing would have a market cap in the tens of millions, not the hundreds.
If you’re looking to take a lotto pick type trade on a beat-up energy name, there are plenty of more compelling options than Chesapeake Energy stock.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.