Carl Icahn (Trades, Portfolio) of Icahn Capital Management LP has been bullish on Chesapeake Energy (CHK, Financial), and the legendary investor increased his stake in the company during the first quarter. Icahn currently holds 73,050,000 shares of Chesapeake Energy. This article discusses why Chesapeake Energy holds long-term growth potential even when the stock has been depressed in the past.
The single most important factor for Chesapeake Energy trending lower is the trend in natural gas price. In the last two years, natural gas price has been volatile and moved above $7/MMbtu in early 2014. However, natural gas prices started to trend lower from the second half of 2014 and this translated into lower stock price for all dominantly gas producing companies.
Since January 2015, natural gas prices have been largely sideways and I believe that it is close to bottoming out in the coming months. The reason for this outlook is the fact that natural gas companies have drastically cut investments, and according to the latest EIA drilling productivity report, the month-over-month change in natural gas production has been negative for most of the prime assets in the United States. I believe that with lower investments and lower production, the supply-demand balance will adjust and natural gas will gradually trend higher.
With this background, I will now focus on the positive factors related to Chesapeake Energy for the long-term. The first point I want to mention is that the southern Marcellus and eastern Utica divestiture generated approximately $5 billion in cash for the company in FY14 and as of March 2015, the company still had $2.9 billion in cash. Further, as of March 2015, Chesapeake Energy had $4.0 billion in undrawn credit facility. Chesapeake Energy is well positioned with $6.9 billion in available liquidity as of March 2015.
While lower natural gas prices can potentially result in cash burn in the near-term, the company is looking to offset that risk through lower capital expenditure. As of 1Q 2015, the company expects to close FY15 with total liquidity of $6.0 billion. In other words, the company’s cash position is likely to remain strong at $2.0 billion as of FY15 with $4.0 billion in undrawn credit facility.
The company’s capital expenditure program for FY14 is $3.0 to $3.5 billion and even if the capital expenditure remains the same for FY15, the company will be largely funded through cash in hand and operating cash flow. Therefore, I expect no meaningful increase in the company’s debt profile over the next 12-18 months. If natural gas prices were to trend higher, Chesapeake Energy is likely to increase its investments for FY15 accordingly and I believe that the increase in spending will be in line with an increase in operating cash flow to maintain a strong financial profile.
The above discussion makes it clear that Chesapeake Energy is well positioned even in difficult times to make strong investments in the coming quarters through internal cash and maintain a healthy balance sheet. The current decline is a value investment opportunity for investors with a time horizon of 3-5 years.
Investors might question why Chesapeake Energy has declined by 42% amidst strong fundamentals. There are two factors in my view – first, the decline in natural gas price has resulted in decline in the stock, and second, the company’s sharp cut in capital expenditure and meaningful decline in OCF has translated to negative sentiments in the markets. Further, Chesapeake Energy expects production growth of just 1% to 3% for FY15. Therefore, the company is not lined up for growth in FY15 and potentially in FY16, but the fundamentals will remain strong and quality assets will drive long-term growth. While I am not suggesting big exposure to the stock at this point of time, gradual exposure can be considered.
From a valuation perspective, Chesapeake Energy is trading at a trailing twelve month EV/EBITDA of 2.99, price to sales of 0.41 and price to book value of 0.76. These are clearly very attractive valuations and the best time to consider any stock for long-term investing is when the sentiments are bearish.
In good times, Chesapeake Energy has proved its capability and also proved that it has quality assets. In difficult times, Chesapeake Energy is maintaining a strong balance sheet health. I therefore consider Chesapeake Energy as a good investment and would recommend gradual exposure to the stock being cautiously optimistic.
