Chesapeake: What Are the Odds of a Comeback?
We take a look at the possibility of Chesapeake making a comeback after assurance of a credit line and substantial recovery in oil price
As of late, oil and gas companies have given in to pressures from the oil price plunge during the first half of this year. Even now, a depressed crude environment continues to dent their financial performance. However, the current year for Chesapeake Energy Corporation (CHK) has been comparatively better, with the stock gaining 12% up till now.
The second largest natural gas producer, Chesapeake Energy, closed down 2% on the New York Stock Exchange, following RBC Capital's downgrade from a Sector Perform to Under Perform rating. The downgrade is primarily driven by concerns of meeting its debt obligation of around $2.2 billion and outcomes of the company's latest asset disposal spree.
RBC Capital Market's Take on Chesapeake
The equity research firm highlights that the company needs to make debt payments of $1 billion in 2019 and another $1 billion in 2020. That said, it needs a solid free cash flow to fund the debt payments – but given the current outlook of oil and gas prices – it is highly unlikely for Chesapeake to manage free cash flow.
According to the latest quarterly filings, the company has total debt of around $10 billion, and has reported accumulated loss of around $450 million over the past 12 months. The firm contends that it will continue to pursue its asset-divestment plan, but the contribution to its EBITDA will not be lucrative to the company.
Chesapeake has announced to spin off 42,000 net acres in the Anadarko Basin to Newfield Exploration Co. in a deal worth around $470 million. It also plans to monetize its $385 million stake of oil and gas assets to FourPoint Energy. Analysts however believe that the company will be better off selling acreage in Canadian counties, including Dewey, Blaine, and Kingfisher.
RBC Capital conducted a thorough analysis on Chesapeake’s free cash flow position. With consistently negative free cash flows and low oil price — dividend payout is out of question. If the company plans to pay dividends it needs to rack up further loans which may aggravate its already fragile liquidity position. As of March 31, the company’s free cash flow deficit stands at around $498 million. On the flip side, its cash and cash equivalent stood at $16 million at the end of first quarter.
Chesapeake’s Cost-Cutting Initiatives and Debt Swaps
Like many other companies, the energy company has opted to exhaust all measures to deal with the ongoing downturn, including asset disposals, reduction in capital expenditure, and laying off employees. The company is going through a repair mode where it plans to sell assets to conserve cash and strengthen its balance sheet. Since the start of 2016, the company has managed to raise $1.3 billion through asset disposals that place it at the lower end of its 2016 asset disposal target of $1.2–1.7 billion.
Debt-to-equity swap is quickly gaining traction among companies mired in large amounts of debt. Companies are waiving off their debt in exchange for newly issued common stock, driving a better leverage position. The company is continuously being pressurized by creditors to make timely coupon and interest payments.
From May 16 through May 23, the exploration and production company has agreed to issue new common stock of 37.08 million, which represents 5% of the company’s existing share count.
Chesapeake – whose debt currently stands at $10.06 billion – has a debt to equity ratio of 662.32%. It has been around 24 months since oil prices began to plunge, but the company’s long-term debt is on a gradual rise. This gives us an indication that the company is struggling to generate profits and continues to take loans to finance operations. The following chart shows the energy giant’s debt position since the start of the oil crisis.
Chesapeake’s total revenue is on a decline — thanks to the steep decline in its oil, natural gas and natural gas liquids (NGL) segment that drove the overall decline in the company’s bottom and top line. The following chart depicts the overall decline in revenue, while the other charts illustrates the performance of its oil, natural gas and NGL segment – the top contributor to its revenue – since the beginning of the oil crash.
Last month, the energy giant reported its first-quarter financial results, posting a loss of $1 billion. The results took investors by surprise when the company announced reaffirmation of a $4 billion credit facility of its borrowing base. The reiteration in credit facility comes at a time when other companies are reporting steep declines in their credit lines.
It is also worth noting that the improvement in commodity price was not the catalyst that drove its stock price and revamped investor confidence in the stock. The company in April announced that it has cracked a deal with its lenders — who have agreed to provide covenant relief and relaxation on interest coverage.
Following the reaffirmation of its credit facility, investors took a sigh of relief since the bankruptcy risk was averted. A Chapter 11 bankruptcy is surely not a possibility in the near term. However, aggressive debt-to-equity swap deals will reduce debt and also dilute the ownership of existing shareholders.
Oil price slumped below $27 per barrel at the start of 2016 — hitting its lowest in a decade. However, since February, oil prices have substantially recovered following the panic sell off in early 2016. Investors are highly recommended to remain patient, while expecting further dilution as the company is seriously considering to reduce debt and survive the low commodity and oil price environment.
For now, the fundamental picture of Chesapeake remains favorable. The reaffirmation of credit facility and energy price recovery is good news for its shareholders who have stuck with the company up till now. We believe that the worst has bottomed out and investor sentiment is improving. A long-term investment with Chesapeake seems good from this point onward.
For more information on Chesapeake financial performance and history, refer to our Chesapeake Data Analysis section.
