Current CHK Stock Info

Chesapeake Energy Corporation (ticker: CHK) is the second-largest producer of natural gas and the 10th largest producer of oil and natural gas liquids in the U.S. The company is actively selling down sections of its business to centralize focus on the Eagle Ford and Utica plays. Approximately $4 billion in divestments were made in 2013 and CHK anticipates selling another $4 billion in 2014. The company is executing a spinoff of its oilfield services unit, as announced in February 2014, and expects the deal to be complete by June 30, 2014.

Divesture Overview

Chesapeake reviewed ongoing operations in an analyst day on May 16, 2014. The company has sold approximately $925 million in asset sales to date in 2014. Deals are in place to sell non-core assets in Texas and Oklahoma for approximately $310 million in cash proceeds. Additional divestures in southwest Pennsylvania and Wyoming are expected to return $290 million in cash to CHK. Despite the sales, CHK says it will lose only 2% of production and $250 million of operating cash flow.

At the analyst day, Doug Lawler, Chairman and Chief Executive Officer of Chesapeake Energy, said: “You see a lot of companies out there that are increasing CapEx and increasing production. You see some that are increasing CapEx and decreasing production. Chesapeake is increasing production and maintaining flat CapEx. As we look at the current outlook today, the work has taken place in the Company to continue to improve our balance sheet.”

The company is also selling CHK Cleveland Tonkawa, its subsidiary, to eliminate roughly $1 billion in equities paid to third parties. Upon its completion, CHK will receive a dividend of $400 million which will be used to pay down additional debt. The new company will be named Seventy Seven Energy and is expected to be completed by June 30, 2014.

Management said all sales and spinoffs will reduce CHK’s net leverage by nearly $3 billion. Additional benefits include $200 less in capital expenditures and $70 less in interest expenses. Total sales and divestures for 2014, once existing deals are closed, will surpass $4 billion.

Chipping Away at Debt

Reducing debt and leverage has been a staple of CHK’s business operations since 2012 and divestures have accelerated since management changed in January 2013. By December 2014, as forecasted by CHK management, debt will drop to $11.8 billion, which is 10% lower than December of 2012. Adjusted net leverage is expected to drop by 30% over the same time frame, or $6.2 billion less.

CHK is enforcing the debt reduction trend by hedging the majority of its 2014 production. Approximately 64% of its natural gas is hedged along with 70% of oil production. The company has also moved to a pad drilling system that will account for 90% of all drilling operations by year-end 2014. A total of $470 million is expected to be saved under the new format coupled with faster drilling times and longer laterals, and a total of $1 billion in annual costs are projected to be saved if the supply chain is considered.

Remaining Properties Expected to Grow

The Eagle Ford remains the focus of CHK’s new properties and will receive 35% of expenditures in 2014. The company plans on running 15 to 20 rigs in the play and 2015 production, adjusted for divested 2014 production, will grow 7% to 10% on a year-over-year basis. The growth is not projected to be a one-time occurrence – CHK expects five year annual production growth of 7% to 9%.

2014 production will start the trend by increasing 9% to 12% compared to 2013. Forecasted production is 675 MBOEPD to 695 MBOEPD, and revenue from liquids is expected to increase by 29% to 33%. The Eagle Ford has rapidly become one of the top hydrocarbon plays in the United States. Sanchez Energy (ticker: SN) operates almost exclusively in the region, and other majors like EnCana Corporation (ticker: ECA) and Devon Energy (ticker: DVN) have spent $3 billion and $6 billion, respectively, to jump into the region.

Nick Dell’Osso, Chief Financial Officer of Chesapeake, declined to rank the projects, but did single out other plays. “We love our position in the Eagle Ford,” he said. “The Utica is very strong for us. The Marcellus is very strong, Haynesville emerging with the strength that we are seeing there, it continues to look very good so it’s a little bit difficult to say, because they are all contributing. And the beauty of this Company is we are not a one trick pony. We’ve got a portfolio of assets that can be optimized to drive greater value.”

While gains have been made, Dell’Osso said work is still left to be done. “The strategy is not to become investment-grade. Becoming investment-grade is an outcome of the strategy. The strategy is to create value. The strategy is to grow this company and in doing that, the things that you are seeing in this presentation and the things that you will see all day today equate to a company that has a much stronger balance sheet and has investment-grade credit metrics, which gives us the confidence that this will happen and it will be an outcome.”

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Analyst Commentary

BMO Capital Markets (05.20.14)

We’re revising our estimates and NAV based on detail shared by the company as part of today’s analyst day. We’re maintaining our Market Perform rating. We see some upside to our +$30 NAV (pro forma for the asset divestitures/monetizations and debt reduction), but don’t observe much by way of meaningful multiple compression in the out periods, despite the capital efficiency gains touted by the company, among other things. That’s all rooted in the asset base, one where returns are still dependent on NGL and natural gas prices. We see the same less compelling comparison when reviewing debt-adjusted growth measures. Included in the company’s presentation today was revised guidance for 2014 adjusted for asset sales, as well as an outlook for 2015 that calls for 7-10% production growth on capital spending of $5.5-$6.0B. That compares to our original 7% company-wide estimate on capital spending of ~$5.6B, including capitalized interest. Surprising was the more formal five-year annual production growth guidance of 7-9%. We appreciate the confidence such a multiperiod outlook implies, but don’t see much upside to the long-term commitment. Things can change for this price taker. Impact & Analysis: We scrubbed our 10 well economics models that are the engines to both our absolute valuation analysis and production forecasts. In Exhibit 1 we show the field-level returns, ranging from MS Wet at ~60% on the high end to Cleveland/Tonkawa at ~20% on the low end. We’re also modeling the sale of the oilfield services business, a change that includes debt elimination/reduction and cash dividend received. Proceeds from certain non-core asset divestitures anticipated this year and totaling ~$290 mm are also captured in our model. Valuation &
Recommendation: We rate CHK Market Perform. We see the stock trading at 6.5x our 2014 EBITDA estimate, and compressing at a not-so-fast pace in 2015 (6.2x) and 2016 (5.3x). Debt-adjusted EBITDA and CFPS growth figures are sub-20% in the out periods on our estimates. Maybe better than what the “old” CHK could have produced, but a new reality that’s fully known at this time, in our view.  

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