Is Chesapeake Out of the Woods?
Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Chesapeake Energy Corporation (NYSE: CHK) traded up in recent weeks. This rally was despite the decline in natural gas prices. There are still speculations about the future of the company in light of its high debt especially in this economic climate in which raising debt is much harder than in the pre-2008 era. The company continues to sell off its assets to keep its head above water: the company estimates to sell between $11.5 and $14 billion of its assets – it will need to sell at least $7 billion in 2012 just to avoid another credit rating reduction. Let’s examine the company’s recent financial reports. Let’s also see if the company is heading out of the woods which could explain the stock’s recent recovery.
Chesapeake's Financial Reports for Q2 2012
According to the recent quarterly report (Q2 2012) the company’s revenues rose by 18% compared to the second quarter of 2011. But the operating profit declined by 25%. Therefore, operating profitability declined from 29% in Q2 2011 to 22% in the second quarter of 2012. Since the company’s oil and natural gas production rose during that time, the drop in profitability was most likely due to the tumble in natural gas prices.
As a comparison, other oil and natural gas producers such as Exxon Mobil Corporation (NYSE: XOM) and Chevron Corporation (NYSE: CVX) didn’t do much better in terms of profitability during the second quarter of 2012. The chart below shows that all three companies’ operating profits ranged between 20% and 22% for the second quarter of 2012. This outcome was an improvement for all three companies compared to the first quarter of 2012. The table also shows that during the last two quarters of 2011, Chesapeake’s operating profits were much higher than its competitors – Exxon and Chevron.
During Q2 2012, the company’s oil production rose by 22% from the previous quarter and by nearly 88% from the parallel quarter in 2011. There was also a rise in natural gas production, which was very modest gain compared to the gain in oil production: during the second quarter of 2012 the NG production rose by only 4% from Q1 2012 and by 25% from Q2 2012.
Chesapeake has already sold $4.7 billion worth of assets during the first half of the year and is expected to sell an additional $7 billion worth of assets throughout the third quarter of 2012. If the company will manage to sell its assets as planed, Chesapeake could repay its $4 billion short term loan.
Oil and Chesapeake
During recent weeks the prices of oil increased: the price of WTI rose by 9%; Brent oil, by 9.3%; United States Oil (NYSEMKT: USO) also increased by 9.6%. This rally may have been related to the rising tensions in the Middle East, in particular the renewed tensions between Iran and Israel. The hotter than normal summer in many parts of the world, the commencement of the Hurricane Season may have also contributed to the rise in oil prices. Finally, there is also a strong seasonality effect - the summer time is driving season with a higher demand for gasoline – that contributes to a rally in oil prices.
The relation between Chesapeake and oil prices varies over time but is mostly strong and positive, i.e. as oil prices increase, the stock price of Chesapeake tends to trade up. During the past month the linear correlation between the stock price and oil (spot) was 0.51; this means that almost 27% of Chesapeake's rally could be explained by the increase of oil prices. Nonetheless during the year the linear correlation between the two was much lower at 0.357.
S&P500 and Chesapeake
The S&P500 also rallied in recent months: during August the S&P500 index increased by 2.8%. The better than expected financial results for Q2 2012 of the top companies was a contributing factor for the rise in the index. The talks of ECB to purchase bonds that could help the major EU economies, including Spain and Italy, also positively affected market sentiment. There were several publications regarding the progress of the U.S that showed some signs of recovery; the U.S GDP expanded by 1.5% during the second quarter of 2012; retail sales rose during July 2012. The recent modest rally of the S&P500 may have also contributed to the recovery ofChesapeake's stock. The linear correlation between the stock price and S&P500 daily percent reached 0.46 (during 2012). This means that nearly 21% ofChesapeake's volatility could be explained by the movement of S&P500.
NG and Chesapeake
Natural gas declined by 14.3% during August. By extension United States Natural Gas (NYSEMKT: UNG) also fell by a similar rate – by 12% during the month. The company’s recent move to sell off natural gas related operations may have affected the relationship between Chesapeake's stock and the price of natural gas: during August, the linear correlation between the stock price and natural gas (spot) was 0.4. This means that only 16% of Chesapeake's volatility could be explained by the shifts in the prices of natural gas. If the company will continue to sell its natural gas related operation, it could reduce the company’s exposure to natural gas prices.
Some Final Thoughts
According to the company’s recent financial reports, low natural gas prices continued to adversely affect the company’s bottom line. And yet the company’s profitability was not far off from the profitability of other oil and natural gas producers such as Chevron and Exxon (at least during the second quarter of 2012). If this relatively high profit margin will be maintained, it could signal that at least from an operations point of view the company is still performing relatively well. Some of the recent rally in the company’s stock was due to its relation to other indexes including oil and S&P500. Nonetheless, the huge debt of the company will continue to jeopardize not only the company’s stability but its future growth. Therefore I suspect that until the uncertainty around the company’s future will be lifted, the company’s stock is not likely to recover much.
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liorc has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil 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. Motley Fool newsletter services recommend Chevron. 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.
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