Chesapeake Could Fall Further on ITG Report
Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
ITG Investment Research released a report this week that Chesapeake Energy's (NYSE: CHK) total proved reserves could be as much as 30% lower than the company's own statements. ITG made its estimates based on publicly available information, and indicated that the lower estimate is largely due to a difference of opinion between it and Chesapeake on the speed of production volume declines. However, it capped its report by stating that a significant portion of Chesapeake's reserves "have no positive value." ITG performed the analysis based on requests by institutional investors.
If true, ITG's allegations could open another door to litigation for Chesapeake, which is already fending off more lawsuits than can be kept track of without a list. Its various woes point to a stock that is poised to go lower by the end of this year, and with the recent flip of its support level turning into its new resistance level, the opportunity might be soon. Still, investors should be aware of the up- and downsides of Chesapeake before jumping in, since Chesapeake is the definition of unstable.
A Bright Spot on the Horizon
Plans to export liquid natural gas (LNG) from the Louisiana coast by Cheniere Energy (LNG), the first U.S.-based project of its kind, caused natural gas prices to gain strength last week, and gave natural gas companies like Chesapeake a reason for hope. Cheniere indicated in its announcement that it achieved financing for two trains of the project amounting to $5.4 billion in commitments, allowing its optimistic projection that Cheniere could be exporting 1.1 bcf of LNG per day by the end of 2015. This would not only benefit Chesapeake but its more heavily gas-weighted peers such as Devon Energy (NYSE: DVN) and Encana (ECA). Devon currently has a production split of 60% natural gas and 40% oil and liquefied natural gas.
By the same token, I doubt that Apache (NYSE: APA) would look at U.S.-based LNG export as a net positive, since it is exploring the same option in British Columbia with its Kitimat project. The proposed Louisiana location for Cheniere would put Cheniere in a competitive position, since it would be in the heart of the terminus for several major pipelines, making delivery to Cheniere more attractive for some producers. On the other hand, Apache has its and its partner EOG Resources' (NYSE: EOG) Canadian production to rely on, which with Apache's newest find might be more than adequate at full scale production. EOG has a 30% working interest on the Kitimat LNG Project.
Moving Staff to Support Production
Chesapeake is planning to headquarter its operations on the Utica shale in new offices in Ohio, after purchasing 291 acres in an industrial park in Louisville. Regarding the move, Chesapeake's Director of Corporate Development Keith Fuller indicated that Chesapeake "looked for a centralized location with the necessary acreage to accommodate our expanding work force and growing operations here in Ohio." What I find interesting about this statement is it forms a nice corollary to the fact that much of the production Chesapeake intends to keep from its major asset sales is located east of the Mississippi, far from its Oklahoma City headquarters, which are surrounded by assets held for sale.
Even before the Louisville purchase, real estate pundits in Fort Worth, Texas were speculating that Chesapeake's four-year-old corporate office tower in downtown Fort Worth was on the market. In support of the idea, brokers point to multiple indicators, including that the balance of a $55 million mortgage on the property is due in June 2014, that 70,000 square feet of the space remains empty, and that Chesapeake has multiple other properties in Texas on the market. Since Chesapeake is also planning to exit the Woodbine Sand and the Permian Basin, I think it's likely that this piece of corporate property will be up for sale once the Louisville field office approaches completion.
Meanwhile, Chesapeake is attempting to renegotiate lease contracts with landowners in Ohio under the threat of losing the contracts altogether since many are not held by production as required in the original lease terms. The major reason for this is Chesapeake's pullback on active rigs caused by the simple necessity to preserve as much cash as possible. Now it might be paying for that decision, as I believe it's safe to guess that landowners will be leery of sticking with Chesapeake and its bad publicity while they have an out.
Employee Benefits: a Thorn at All Levels
As rumors swirl that not just premium property but the whole Chesapeake organization is on the auction block, revelations about Chesapeake's employee benefits are emerging that give one pause about the corporation's core operating instincts. By now CEO Aubrey McClendon's many questionable benefits are old knowledge, but it was recently revealed that 1,600 contracted mid-level employees would receive a change of control payment should the company change hands - even if the employee kept their position with the new controller. Reuters estimates that the bottom line charge on this agreement could amount to between $100 and $140 million, which is either a very generous compensation package or an offensive measure meant to dissuade potential takeover. Either way, it appears that the clause is activated not just during a takeover but if the majority of the board of directors is changed "as a result of an actual or threatened election contest." This is nebulous language, to be sure, and though Reuters reports that Chesapeake does not believe the Board changes in June triggered the clause, there is now room for debate; in fact, Paul Hodgson of GMI Ratings believes Chesapeake is now on the hook for the payouts.
Chesapeake's legal costs were just reduced, though its burden of proof was raised at the same time, as a federal judge in Oklahoma City consolidated thirteen shareholder lawsuits pending against Chesapeake's board of directors into one. The lawsuits are mainly centered on McClendon's participation in the Founders Well Participation Program and subsequent mortgaging of his well rights; the litigants allege these actions amount to breach of fiduciary duty and conflict of interest, which the Board could and should have prevented.
Outlook
Though it is trading higher than its May low of $13.32, struggling Chesapeake is not receiving substantial relief from the pressures on multiple fronts pushing down its stock. Current trading around $17 gives Chesapeake a price to book of 0.9 and a forward price to earnings of 8.5. Though ordinarily I would think this is an excellent deal, I believe that Chesapeake is ready to take another fall, especially if ITG's report on Chesapeake's true reserves influences further investigation. More than any other parameter Chesapeake needs those reserves to maintain its value, and any further doubt about Chesapeake's actual value could cause a plunge. I would be looking for an entry at or below $17, with a hold until Chesapeake manages to break $22 with some good news - possibly the sale of its Permian assets.
jordobivona has no positions in the stocks mentioned above. The Motley Fool owns shares of Devon Energy and has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2013 $25.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
