On June 28, 2020, Chesapeake Energy Corp. (CHK, Financial) and some of its subsidiaries filed voluntary petitions under Chapter 11. According to David Blackmon, writing in Forbes magazine (“Chesapeake Energy Finally Succumbs With Chapter 11 Filing”), the company had been losing ground for more than a decade.
He reported the company bet, in the 2000s, that natural gas would be scarce in coming years and then went on a buying spree. As a result, the company bought natural gas assets and companies at high prices and incurred lots of debt. That story ended with Chesapeake in bankruptcy court.
But that was then, and this is now, as the old saying goes. The difference obviously is that oil and gas prices came out of the basement and shot into the attic. Petroleum companies that survived the loss of demand and low prices now look like winners again.
About Chesapeake Energy
The company is an independent exploration and production company that produces oil, natural gas and natural gas liquids, or NGLs, from approximately 8,200 gross oil and gas wells. It operates in three states: Pennsylvania, Louisiana and Texas.
Based in Oklahoma City, Oklahoma, it has a market cap of $12.61 billion and on a trailing 12-month basis had revenue of $7.32 billion.
Since it came out of bankruptcy in February 2021, it has been actively buying and selling assets and companies. In November 2021, it bought Vine Energy, which is also involved in shale plays in Louisiana, for cash and shares.
January 2022 saw Chesapeake acquire Chief and assets held by Tug Hill for cash and shares. These two companies also operated in Marcellus Shale area of Pennsylvania. That same month, it agreed to sell its assets in Wyoming for cash.
In its third-quarter 2022 investor presentation, it could point to several achievements that should make it attractive to investors:
Competition
Chesapeake noted in its 10-K for 2021 that it competes with both integrated and independent oil and natural gas companies. In addition, it faces indirect competition from alternative energy, including wind, solar and electric power.
Still, it feels it has competitive advantages; it said, “We believe that our technological expertise, combined with our exploration, land, drilling and production capabilities and the experience of our management team, enables us to compete effectively.”
This performance chart compares Chesapeake with two leading exploration and production companies that produce both oil and gas. The first is Canadian Natural Resources Ltd. (CNQ, Financial) and the second is ConocoPhillips (COP, Financial):
Despite its fall from grace earlier, Chesapeake is now keeping up with the big kids in its industry.
Financial strength
Bearing in mind that Chesapeake recently went through Chapter 11 proceedings, my assessment of its financial status will start with a history of its long-term debt.
To get itself out of its “legacy” debt, worth some $20 billion, the company canceled its existing common shares and “new common stock” were issued to lenders. That has turned out to be a good deal for lenders, but for legacy shareholders, investing in Chesapeake was a disaster.
At emergence from the proceedings, the company negotiated $925 million of debtor-in-possession financing, a $600 million rights offering and a $2.5 billion exit financing package.
Chesapeake also received permission to use fresh start accounting, which meant it could become a new entity for financial reporting purposes.
Turning to its current financial situation, which began on Feb. 9, 2021, it receives this assessment from GuruFocus:
Chesapeake receives a 5 out of 10 ranking for its financial strength, based on its debt (as measured by the interest coverage ratio), its debt-to-revenue ratio and Altman Z-Score.
Starting with the interest coverage ratio of 10.28, the company is on solid ground, producing $10.28 in operating income for every dollar of interest on the debt.
The debt-to-revenue ratio comprises trailing 12-month debt of $2.71 billion and trailing 12-month revenue of $7.32 billion. That’s a ratio of 0.37, which is adequate.
The Altman Z-Score is 1.75, which puts it on the high end of the distress zone and just below the grey zone, which begins at 1.80.
Overall, it appears 5 out of 10 is a reasonable ranking for this formerly bankrupt stock.
Profitability
Chesapeake receives a ranking of just 4 out of 10 for profitability based on its operating margin, Piotroski F-Score, the trend of the operating margin and the consistency of its profitability:
The trend of the operating margin is measured over the past five years and the consistency of profitability is measured in previous years, not months. Logically, then, we should expect a low ranking because these two measures take in the period when Chesapeake filed for and went into Chapter 11.
The operating margin is relatively good, with the light green bar signifying an above-average margin for the oil and gas industry. The Piotroski F-Score has risen to 6 out of 9, after finishing 2021 at 3 out of 9.
Growth
All those red bars on this table signal a company in trouble:
However, these are three-year metrics and so they include the bankruptcy period. When Chesapeake came out of bankruptcy, it had much cleaner financial statements, so if we were to break out these metrics on a year-by-year basis the last one would be much better.
Here's what President and CEO Nick Dell'Osso said in releasing the first-quarter 2022 earnings, "Momentum continues to build for Chesapeake as we execute our returns-focused strategy. We delivered record quarterly adjusted free cash flow, initiated our $1 billion share and warrant repurchase program and continued realizing the synergies anticipated from the Vine transaction, which we look forward to replicating with our recently closed Chief assets.”
Reflecting on second-quarter improvements, the company announced in its earnings release it had increased its base dividend by 10% and that it had retired some $670 million, or approximately 7.6 million common shares. It also doubled its shares and warrants buyback allocation to $2 billion.
More of the same came in the third-quarter report, as the company announced it had increased the quarterly dividend and repurchased common shares and warrants.
For this company, growth in the past year is almost the opposite of the previous two years.
Dividend and share repurchases
Chesapeake has both a base dividend and a variable dividend. In the third quarter of 2021, the company adopted a variable return program that would lead to additional (variable) dividends, beginning in March 2022. These payments would be “equal to the sum of Adjusted Free Cash Flow from the prior quarter less the base quarterly dividend, multiplied by 50%.”
For the most recent quarter, the company paid a base dividend of 55 cents and a variable dividend of $2.61, for a total of $3.16 per share. Based on a share price of $98.42 on Dec. 12, that works out to a yield of 9.74%.
Is that yield sustainable? It will be as long as it can generate similar or higher adjusted free cash flow. That, in turn, depends on both the economy and oil and gas prices. It is worth repeating that this is a variable dividend, which provides flexibility for the company and occasional bonuses for investors.
Turning to share buybacks, Chesapeake reported in its third-quarter earnings release that it had bought back 11.6 million shares so far in 2022. Still, that’s only a fraction of the new shares created coming out of Chapter 11:
The company also reported that 80% of the shares it repurchased came from former creditors. That suggests many creditors have recovered much of what was owed to them. It also should remind current investors that previous shareholders suffered heavy losses.
Valuation
Since Chesapeake’s reorganization was in the immediate past, many measures of valuation are not available. However, it has a price-earnings ratio of 5.13, which is better than 67.96% of companies in the oil and gas industry. It has a meaningless five-year Ebitda growth rate, so there is no PEG ratio. Similarly, there is not enough data available for the GF Value chart.
It is worth noting that share price has leveled out in recent months after a fairly steady rise.
Gurus
Chesapeake is a favorite of Howard Marks (Trades, Portfolio) of Oaktree Capital Management; he owned 9,800,000 shares at the end of the third quarter. Those shares represented a 7.32% stake in the company and 11.32% of his fund’s assets under management. Jim Simons (Trades, Portfolio)' Renaissance Technologies is also a significant investor with 1,071,820 shares, while Charles Brandes (Trades, Portfolio) of Brandes Investment had the third-largest holding at 163,301 shares. Altogether, 12 gurus have positions in the company.
Institutional ownership shot up to just under 98% of shares outstanding at the end of 2021, before settling down to 69.64% at the end of the third quarter of 2022.
Conclusion
Chesapeake has risen from the ashes of a bad strategy call. The unmanageable debt load was shed, and lenders accepted new common shares to cover their potential losses. And since shareholders are lowest in the pecking order, they had to take the big losses.
Since emerging from bankruptcy, the company has turned itself around and is now a solid performer with a high dividend. Will it continue to deliver capital gains and dividends? Again, tell me where oil and gas prices are going, and you may know the answer.
