This Energy Company is Ready for Your Money

By John Mylant - September 15, 2012 | Tickers: APC, CHK, HAL | 0 Comments

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It may be time to stop and look at Chesepeake Energy again! It has been months now since investors have gone on the warpath against Chesapeake Energy (NYSE: CHK) because of its summer financial mismanagement revelations. The company seems to be getting on the right path. But another factor to keep in mind before one invests is that there are signs that the whole shale oil industry may be at a cyclical high because of debt ratios. So an investor should be cautious jumping back into the company without researching the industry as a whole.

Analysts are interested in Chesapeake as a real company even though it doesn’t look like it. Two things have helped the company pick up interest from investors. Dan Loeb bought into the company and management is doing to good job getting back to core business. For Mr. Loeb, this became his fourth largest investment and at the point he entered. He bought into bonds, possibly observing the recent changes in the governing board of the company. These changes may have created some stability for the bonds and they may be safer than they have been in the past. The recent plans and sales of non-core business is allowing the company and management to focus on its core business rather than worrying about balancing books all the time. Chesapeake's liquids production growth is up 65 percent over the past year, or 52.3 Mbpd, all from drilling. The shift would lead to higher returns on invested capital, lower capital expenditures and a more streamlined company. It has never really made a profit on natural gas, but the simplification of business can now focus on natural gas alone and making money.

Investors are interested in Chesapeake Energy because it does have so much potential. It is the largest company in the U.S. that focuses upon natural gas. With the development of “fracking” the lower prices than gasoline creates great potential for the future. And if the company holds on, someone may come up with a technology that can export natural gas (that does not yet exist) and this would open up new markets in Europe where natural gas is more expensive. For this reason, investors are willing to gamble on the stock’s potential.

It is true, CHK does have a lot of potential, but there are others investments in the same family that also look good. Anadarko Petroleum (NYSE: APC) boosted its 2012 sales volume forecast as it exceeded analysts expectations this quarter. From a year ago it climbed over 8% which is good for the industry. The company has a lot of momentum behind it. Other companies that an investor also might consider looking at would be: Apache (APA), Noble Energy (NBL), EOG Resources (EOG), and Continental Resources (CLR). Each of these companies represents a good opportunity for energy investment growth.

But as Always, be Cautious                           

Chesapeake Energy still has a soiled reputation to deal with and angry investors to contend with because of its financial dealing that landed it in hot water. The company needs to stick to its core business and keep the company away from another debt crisis.

Investors also need to be cautious (or a where of) the practice by oil and gas exploration companies of spending more on drilling than cash coming into the coffers. The average spending is 43% higher than cash flow. Shale players like Chesapeake (in a way) are using the low interest rates and high yield debt boom to finance drilling programs. The spending deficits are at cyclical highs. Debt levels cannot indefinitely stay where they are and rigs may feel a pullback. This could also cause a pullback in the shale-drilling business. Drillers spent the last 12 to 18 months increasing their capital spending companies have used 90% debt financing. Only in the second quarter did discipline re-emerge, as drillers like Chesapeake hit spending limits. As an investor it is important to be aware of what may be happening in the industry so study and be cautious.

A pullback is already affecting oil rig operators like Halliburton. This will also have a negative affect upon rig contractors like Halliburton (NYSE: HAL). The company is very dependent upon U.S. shale drilling and noted a fall in contract earnings as well as margins as rigs dropped by 17% in count. The company could see earnings drop double digits in the coming quarters. Its North American revenue is supposed to be less in the third quarter than the second. The company's chief financial officer said less drilling and weaker prices for oilfield services would reduce North American profit margins by 2.5 to 3 percent.

Offshore oil and gas companies may be cutting spending by 10%. If this happens, it means 75 rigs could be pulled from the shale-drilling region. It is more likely that a cyclical down turn is on the way instead of a sustained oil recovery. Michael Lamotte, an analyst for Guggenheim Securities says this about the protraction of the industry:

"We continue to believe that the U.S. rig count is in the process of a protracted correction. The key pillar of our thesis is the unsustainability of the growth in debt, which has allowed E&P capex to remain well above levels supported by cash-flow since [the second quarter of 2011].”

Chesapeake energy has made some very good moves as a company lately and deserves to be looked at as a possible investment. But I also believe it is prudent for investors to study the Shale Oil industry before getting back into a possible long term bullish position with companies like Chesapeake Energy. If the debt ratios will cause a pull back in drilling a timing issue may remain before investing.

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