While I have written a few articles regarding Chesapeake Energy Corp. (NYSE:CHK) over the past few months, the last time I wrote about the firm’s cash flow potential was on May 27th of this year, nearly three months ago. Since then, times have been particularly unkind, not only to shareholders of the business but also to the oil and natural gas markets, and I figured it’s about time, given these changes, as well as changes to management’s guidance for the firm, to dig into the data and give my thoughts on what it all means for Chesapeake moving forward. The general conclusion here is not positive.
A look at what has transpired
Since the publication of my May 27th article showing the cash flow potential of Chesapeake, shares of the business have tanked 27.2%. While a general malaise regarding energy companies appears to have taken hold, even for higher-quality firms, perhaps the larger reason relates to a retreat in energy prices that has taken a toll on firms’ bottom lines. Oil prices, for instance, have fallen 5.1% from $50.33 per barrel down to $47.74 per barrel, while natural gas prices have plummeted 9.8% from $3.256 per Mcf to $2.937 per Mcf as of the time of this writing.
In addition, since the publication of said article, management has come out with new financial expectations for Chesapeake. Personally, I had expected the firm to scale back on its capex program in order to preserve some cash, but this did not come to pass. Alas, management is intent on spending, at the mid-point, $2.1 billion toward capex this year. This excludes around $200 million for capitalized interest. In the table below, you can see the most recent guidance provided by management for this year:
*Taken from Chesapeake
For my own work, I am going to rely on some assumptions. For starters, I am going to assume that energy prices remain unchanged in perpetuity (they are likely to rise in my opinion), with oil set at the aforementioned amounts they are at as of the time of this writing. I’m also assuming that no major corporate changes (like asset sales, debt reduction, etc.) take place, and I’m going to operate under a scenario where guidance for this year applies to all subsequent years with current capex resulting in production growth in 2018 of 10% while 2019 sees a further 10% growth in production (keeping all else the same, lower production growth than this will hurt cash flow). I’m also going to use a scenario where the midpoint of all provided guidance is what management actually achieves and that all debt that does come due between now and the end of 2019 can be refinanced under existing terms.
Cash flow isn’t looking pretty
The bad thing about some energy companies, especially those that are not well hedged, is that small fluctuations in energy prices can send their cash flow falling significantly (though they can also result in material increases in cash flow if prices rise). Chesapeake, sadly, is no exception to this rule. If you look at the table below, you can see my prior projection for the company’s cash flow for this year, 2018, and 2019:
*Created by Author
This year was looking to be pretty bad, with high capex resulting in net outflows of $721.64 million. However, that was expected to improve drastically in 2018, with cash outflows nearly falling by half to $434 million, followed by a further improvement to an outflow of $252.85 million in 2019. Although this is worse than what management has expected (it previously stated its goal to be cash flow neutral in 2018), its own assumptions probably rely on higher energy prices, lower costs (management should be able to cut some costs) and may have incorporated potential asset sales.
Now, however, as the picture has changed, driven largely by a decline in energy prices, cash flow looks a lot worse. This year, we should see net outflows of around $854.14 million. That should increase to an outflow of $870.09 million in 2018, followed by an outflow in 2019 of $707.93 million. In the table below, you can see precisely what I mean regarding these forecasts. I should mention that my numbers are not necessarily representative of “free cash flow” in the traditional sense because I am factoring in the payments of preferred distributions (I factored those in my prior forecast as well). If need be (and I think management should go this route), it can shave some cash outflows off by stopping payment on preferred distributions again, plus it could consider allowing production to fall by cutting capex. These are highly recommended considerations.
*Created by Author
What this means for investors is clear in my opinion. Absent a resurgence in energy prices and absent some major change from management (like asset sales, extreme cost-cutting, or something else), Chesapeake could end up in some trouble. This would be a legitimate reason for shares of the business tanking in recent months and for the investor pessimism that sent shares lower.
Based on the data provided, I must say that, while I was once very interested in Chesapeake from the perspective of a potential investor, that interest is temporarily gone. Management would need to initiate a major asset sale (which I know it is looking at) or a series of asset sales. It would also need to cut the preferred distribution again or find some other solution to that situation, and it would need to demonstrate financial responsibility by cutting capex to some degree. Until that happens and/or until energy prices rise materially, I intend to stand by the sidelines and watch what unfolds.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.