How Chesapeake Is Seeking its Redemption
Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Chesapeake (NYSE: CHK) wowed Wall Street on Thursday beating expectations on both revenue and earnings while also raising its production guidance. The quarter marked a big step forward as the company tries to recover from its checkered past. But can Chesapeake find redemption? Let's investigate.
This is the first quarter that Chesapeake has reported under new CEO Doug Lawler. Lawler was hired in June to replace former executive Aubrey McClendon.
McClendon left the company in a mess last year. An aggressive expansion program saddled Chesapeake with an unsustainable debt load and falling natural gas prices, leaving management with a $4.5 billion funding gap by the start of 2013. Plus a series of governance scandals triggered civil and criminal probes into the company. After all this, Lawler faces the tall task of righting the company's financial ship and restoring investor confidence.
In the call he outlined his two-part turnaround plan. First - financial discipline: Lawler promised to balance capital expenditures with cash flows from operations and divest non-core assets. Second - profitable and efficient growth: Management is planning to implement a new capital allocation program to refocus on only on the best performing assets.
Many analysts on the call couldn't quite grasp the concept of financial discipline as was evident in their reaction.
"Let me clarify, for 2014, your expectation is that your all-in CAPEX is going to be at or below operating cash flow? Am I understanding that correctly?" -- Joe Allman, JP Morgan.
"Just want to be clear that you're balancing cash flow and CAPEX." -- David Heikkinen, Heikkinen Energy Advisors
"Again, just to clarify, the DNC CAPEX plus other CAPEX, you're targeted to have it at or below operating cash flow?" -- Joe Allman, JP Morgan
Readers have to understand that this is a shocking development for the company. Lawler's plan represents a 180 degree shift from Chesapeake's previous philosophy.
Already seeing results
But what was really encouraging in the call was evidence that the turnaround was already gaining momentum.
First, Chesapeake's liquidity crisis is over. In February, the company sold a 50% stake in its Mississippi Lime assets to Sinopec for $1.02 billion. Again in July, Chesapeake sold off its properties in the northern Eagle Ford and Haynesville shale formations for $1 billion. With the company closing in on $4 billion in asset sales since the start of the year, Chesapeake has effectively closed its funding gap. Additional divestments later this year will be used to pare down debt and shore up the balance sheet.
Chesapeake is also showing early success on its capital efficiency initiatives as evidenced by strong earnings growth coming with lower capital requirements. It's clear that the company's portfolio is producing above the Street's expectations with the management raising their full-year production guidance by one million barrels.
But Chesapeake isn't clear yet. In recent months investors have been disappointed by the proceeds the company has been able to raise from its divestments. It's clear Chesapeake doesn't have much power at the negotiating table, and the company's assets may fetch less than investors expect.
Those concerns remains. But this quarter suggests Chesapeake is on the right track.
Change is in the air
Chesapeake is just another example of a changing philosophy gripping the oil patch. No longer are companies embracing growth for growth sake. Rather, emphasis is now being placed on earning the highest possible return for investors.
Wait, isn't that just common sense? Yes, but sanity was thrown out the window in the last decade during oil's run to $150/brl.
Nowhere is this better illustrated than Suncor (NYSE: SU). Since taking over at the helm last year, CEO Steve Williams has been relentless in his pursuit of creating shareholder value. He abandoned the company's goal of producing one million barrels of oil equivalent per day by 2020, shelved the Voyageur Upgrader project, and embraced shareholder-friendly initiatives like dividends and buybacks.
Williams' new strategy is to wring out an extra 100,000 b/d over four years through operational efficiencies. De-bottlenecking initiatives - industry slang for tweaking operations in an effort to make them more efficient - are more cost effective and less risky than bold new projects.
And it appears this new strategy is paying off for shareholders. In the past year Suncor has outperformed the Canadian Energy Index by 10%.
Foolish bottom line
Chesapeake is well on its way to redemption. By abandoning the practices of its reckless past and embracing disciplined growth, the company can regain favor with the investment community. This quarter confirms it.
Robert Baillieul has no position in any stocks mentioned. The Motley Fool has the following options: long January 2014 $30 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!