Is Chesapeake Making a Comeback?

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Is Chesapeake Energy (NYSE: CHK) heading in the right direction? The company has yet to gain back the confidence of its investors as the company's stock has yet to recover: Shares of the company have declined by nearly 29% year-to-date. But the company's CDS have sharply declined in recent months, which could reflect some signs of optimism in the company's future. The company decided to replace its outstanding $4 billion loan (nearly half of this loan was already repaid) with a long term $2 billion loan that has better conditions. Will Chesapeake be able to regain the confidence of its investors?

Chesapeake and CDS

Chesapeake's credit default swap (five years, in USD) has decreased during the past several months. It had already reached a very high rate of 891 back in May 2012. Since then, however, the CDS have declined to nearly 640 as of November. This represents a 28% drop. The current CDS means the annual premium is $640 thousand in case of a default of $10 million of debt within the next five years. The chart below presents the changes in the five year CDS price between 2010 and 2012 (weekly prices). Despite the recent drop in the company’s CDS, it is still very high compared to historical levels.

<img src="/media/images/user_12845/chesapeake-cds-2011-2012_1_large.jpg" />

The recent fall in the company’s CDS suggests the market estimates a lower chance of Chesapeake defaulting on its debt in the near future.

One factor that could have contributed to the company’s CDS fall is the set of assets the company sold in order to close the $4 billion loan it took earlier this year. Most recently, the company completed the sale of its remaining midstream assets to Access Midstream Partners for nearly $2.16 billion.

Despite the big asset sales the company wasn't able to repay back its entire $4 billion loan. Nonetheless, Chesapeake replaced the outstanding loan (LIBOR plus 7%) with a $2 billion loan (LIBOR plus 4.5%). The new loan with better conditions might have also contributed to the fall in Chesapeake’s CDS.

So the company has less debt, the chances of default seem to have gone down and it has a loan with better conditions. These factors aren't enough to turn it around for the company, but it is likely to reduce some of the uncertainty around the future of Chesapeake.   

Chesapeake's Micro View

The company’s operating profitability is low compared to previous quarter and with respect to other oil and gas companies such as Exxon Mobil Corporation (NYSE: XOM) and BP plc (NYSE: BP). The table below presents the operating profitability of the above-mentioned companies. It shows that of the three companies Chesapeake has the lowest operating profitability in the third quarter. In regards to Chesapeake's operating profitability, I have adjusted it by excluding the company’s goodwill provisions that were size-able in the third quarter (as the company sold its assets). By doing so, I examine only the core operating costs of the company sans one time accounting provisions.

<img src="/media/images/user_12845/operating-profitablity-chk-bp-and-exxon-dec-2012_1_large.jpg" />

It’s worth noticing, however, the operating profitability of Chesapeake fluctuates very rapidly on a quarterly basis. Moreover, the operating profitability may rise in the last quarter of the year. One factor that could help rally the company’s revenues and operating profitability is the recent increase in the price of natural gas.

Chesapeake and Oil & Gas

The company is among the leading oil and natural gas companies in the U.S. The changes in the price of oil and natural gas tend to affect the company’s revenues and consequently its earnings and stock price. Despite the recent fall in the prices of natural gas, the company might benefit from the rally in natural gas prices during the last quarter of the year. Moreover, if the price of natural gas will resume its upward trend at the beginning of the year (assuming of course the winter in the U.S won’t be warmer than normal), this could pull up the company’s revenues.

The table below present the company’s operating profitability and the normalized quarterly prices (as of the third quarter of 2011) of crude oil and natural gas. The recent rise in the price of natural gas by nearly 23% may pull up the company’s revenues in the last quarter of the year.

<img src="/media/images/user_12845/operating-profitablity-chk-vs-oil-and-gas_large.jpg" />

Based on the above, the company is still not out of the woods. But the recent assets sales the company accomplished, the new long term loan the company managed to secure and the rally in the price of natural gas might suggest the company's stock might bounce back in the months to follow.  

For further Reading:  

Why the Recent Rally in Natural Gas won’t help XOM

Will Exxon Continue To Trade Up?

 Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.

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 2014 $20.00 calls on Chesapeake Energy, long JAN 2014 $30.00 calls on Chesapeake Energy, and short JAN 2014 $15.00 puts 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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