Will Asset Sales Drive This Energy Giant Higher in 2013?

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Plains All American (NYSE: PAA) recently announced that it will acquire Chesapeake's (NYSE: CHK) crude oil and condensate gathering assets in the Eagle Ford shale; the acquired assets comprise throughput capacity of 50,000 barrels per day and 450,000 barrels of storage capacity in a deal worth $125 million.

Chesapeake announced that it planned to sell approximately $12 billion in assets throughout 2012 in order to meet a budget shortfall. It sold assets in the Permian Basin to Royal Dutch Shell and Chevron for $6.9 billion.  Recently, it sold most of its remaining midstream assets for $2.6 billion to Access Midstream Partners, part of a larger $4.88 billion deal announced in June.

If the Plains deal closes as expected by the end of the year, Chesapeake will have taken in $10.8 billion this year from asset sales. Chesapeake's work isn't done yet.  The company will have to sell another $4 billion in assets next year to plug its budget deficit. However, Chesapeake’s strategy of buying up large amounts of acreage has paid off in the past. Just look at Eagle Ford as an example. Chesapeake still has plenty of acreage to sell, and it will be able to reach $4 billion worth of asset sales in 2013.

Financials

For the third quarter of 2012, Chesapeake reported a net loss to common stockholders of $2 billion. The company reported cash flow from operations of $1.1 billion (cash flow from operating activities before changes in assets and liabilities). Chesapeake’s daily production for the third quarter averaged 4.1 bcfe. This marked an increase of 24% from the average production per day in the same quarter of 2011, and an increase of 9% from the average production per day in the preceding quarter.

The Shift From Natural Gas to Liquids

As a result of changing its drilling program from dry gas plays to liquids-rich plays, Chesapeake is projecting its natural gas production to decline approximately 7% in 2013. The company is projecting its liquids production to increase approximately 29% in 2013. Since 2000, it has built a leading position in 10 of what it believes are the top 15 unconventional plays in the U.S. During the past four years, it has substantially shifted its drilling and completion activity to liquids-rich plays in response to strong U.S. oil and NGL prices and relatively weak U.S. natural gas prices.

During 2012 and 2013, the company expects that approximately 85% and 88%, respectively, of its total drilling and completion capital expenditures will be invested in liquids-rich plays. Chesapeake is the second-largest producer of natural gas in the U.S., but with prices under $4 per 1,000 cubic feet, it is losing money on every drop of natural gas that it produces.

Chesapeake has reduced its natural gas drilling by 90% and gone on a crash program to run up the production of crude oil. Since an oil BTU sells today for about four times the price of a NG BTU, this move is in the company's interest.  During the twelve months spanning from March 2011 to March 2012, production increased by three million barrels. It only took six months to increase production by another three million barrels.

Peers

Chesapeake’s peers include Devon (NYSE: DVN), EOG Resources (NYSE: EOG) and Exxon Mobil (NYSE: XOM). Chesapeake trades at a forward price/earnings ratio of 15.60, compared to 17.5 for EOG, 11.5 for Devon, and 10.7 for Exxon. Chesapeake has a price/book ratio of 1, compared to 2.30 for EOG, 1 for Devon, and 2.4 for Exxon. The price/sales ratios were 1.00, 2.80, 2.30, and 0.90, respectively. Chesapeake has the highest earnings per share (EPS) growth rate among its peers. However, Chesapeake’s low margins and debt to equity ratio of 1.30 do not encourage an investment at this point in time. The company needs to take further measures to improve its financial position.

Conclusion

Chesapeake should be viewed as a long-term investment only. The long-term risk reward profile of the company will improve once the asset disposals are completed and the debt burden is reduced. The company still owns the largest amount of acreage in the country and, if the natural gas market recovers, the company will have the option to drill for natural gas. Investors should watch Chesapeake closely and be ready to buy on positive news surrounding the outcome of its asset disposals and debt reduction.


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