Chesapeake Energy (CHK) is one of those companies that just don’t seem to be able to get out of their own way. They have been dogged by controversy over the last few years. Those that follow the energy sector will no doubt remember that founder and original CEO Doug McClendon retired in April of last year amid accusations of irregularities surrounding $1.1 Billion of loans that he had taken from the company. This week came the announcement that the Michigan Attorney General was bringing fraud and racketeering charges against CHK, stemming from their practices in acquiring land leases in the state. Add to that last month’s earnings that missed consensus estimates by nearly 20 percent and it seems that there is no good news around. That, though, is why the stock represents a good buy at current levels.
According to the Natural Gas Suppliers Association (NGSA)CHK is second only to Exxon Mobil (XOM) in terms of production of U.S. natural gas, so is well placed to benefit from the increasing demand and therefore price of the commodity that many analysts are predicting over the next couple of years. That has been the case for a while, though and yet Chesapeake has consistently underperformed both the broader market and the energy sector.
In the last year the stock has lost 6.47 percent compared to an 18.05 percent increase in the S&P 500 and a 12.38 percent gain in the energy sector ETF XLE. Obviously, then, there is risk in buying the stock, but it is beginning to look like all of the bad news is priced in and any good news is being ignored. The stock has lost over 20 percent since the June high and the current price represents less than 12 times forward earnings. Proximity to a logical stop loss level at just below the 52 week low of $24 (at the time of writing CHK last traded at $25.20) means that investors can give themselves a chance to participate in any upside, while limiting potential initial losses to less than 10 percent.
There are plenty of reasons to believe that that upside is pretty good if you look beyond the headlines. The CEO who replaced McClendon, Doug Lawler, has taken some tough decisions. Shedding 1200 employees and disposing of assets when you take over a company as Lawler did doesn’t make you popular, but in light of the fact that revenues have shown significant increases in the last couple of quarters, it looks like this was fat that could be trimmed. A Reuters article from last year, for example, claimed that early cuts included “a meteorologist who made $350,000 in salary, three chaplains, seven chefs, two company archivists, a fitness center staff of 15 people and a gardener.” Lawler has also focused on rebuilding Chesapeake’s balance sheet, paying down debt and buying back some preferred stock. In the short term this has made margins look poor, but over time it gives a more stable platform from which to grow and will make the stock more attractive to investors.
Chesapeake was one of the original shale plays, but has hit tough times as of late, with one scandal and problem seemingly following another. The fact remains, though, that they are sitting on huge reserves of a commodity that is coming into vogue, as evidenced by the fact that the current valuation represents only 1.26 times book value and 0.85 times last year’s sales. At that price and with a CEO focused on efficiency, it looks worth the risk.