The decline for Chesapeake Energy (NYSE:CHK) continues unabated. The stock is already lower by 82% from 2019 highs of $3.44. As fundamental concerns persist, there is little reason to believe that CHK stock can bounce back in the foreseeable future. At this point, between investor worries and formidable headwinds, Chesapeake Energy doesn’t look good.
As I write, Bloomberg has reported that Donald Trump is in no hurry to sign the trade deal with China. Potential delay in the trade deal would imply that economic weakness persists into 2020. From the perspective of Chesapeake Energy, it would imply lower oil and natural gas prices.
There are reports that Russia might not seek more production cuts at the OPEC meeting and that has already weakened oil. In addition, natural gas prices have remained weak due to oversupply. Overall, the scenario is that energy prices might remain sideways to lower in the coming quarters.
This industry headwind has the potential to send CHK stock price lower as EBITDAX margin shrinks. Lower price realization would also imply weakness in operating cash flows and Chesapeake Energy already has weak credit metrics.
As a positive, Chesapeake Energy has been increasing the weight of oil in total production. However, the impact on margins will only be visible when oil trends higher. Energy Information Administration (EIA) expects Brent price to average $63.6 in 2019 and $60.1 in 2020. Therefore, any positive impact on EBITDAX margin can be ruled out in the near-term.
Low Financial Headroom and Leveraging
It is very likely that oil and natural gas prices are unlikely to move higher in 2020. It’s bad news for Chesapeake Energy even if prices remain sideways.
To elaborate, for the third quarter of 2019, Chesapeake Energy reported cash & equivalents of $14 million. Therefore, the company has a low cash buffer.
Further, for year-to-date 3Q19, Chesapeake Energy reported operating cash flows of $1.2 billion and investing cash flows of $1.9 billion. This implies negative free cash flow of $700 million. Since energy prices are likely to remain sideways to lower, it would be optimistic to assume higher operating cash flows.
Chesapeake Energy has already announced plans to reduce its capital budget for 2020 to a range of $1.3 to $1.6 billion. Assuming an optimistic scenario, if the company covers 2020 investment with internal cash flows, a debt of $9.1 billion will remain. Therefore, credit metrics will remain stressed in the coming year. Furthermore, assuming a pessimistic scenario, if oil and natural gas trend lower, debt can increase and worsen credit metrics.
If we annualize YTD 3Q19 EBITDAX, Chesapeake Energy is likely to report adjusted EBITDAX of $2.5 billion. Assuming debt remains at $9.1 billion, the debt-to-EBITDAX comes to 3.64. In its 3Q19 presentation, the company has talked about a target debt-to-EBITDAX of 2.0.
I don’t see that happening in the next 12-24 months unless the company pursues asset sales. In challenging market conditions for the energy industry, Chesapeake Energy is unlikely to get the desired valuation.
Therefore, stressed credit metrics is a key reason for remaining bearish on CHK stock. Asset sale can lower debt, but sale of producing assets will also lower EBITDAX and cash flows.
My Final View on CHK Stock
In a recent press note, Chesapeake Energy mentioned the following – “We continue to pursue strategic levers to reduce debt, including asset sales, capital markets transactions, and focus on cost discipline.”
Capital market transactions would imply equity dilution to raise funds and repay debt. Therefore, CHK stock can possibly trend lower due to equity dilution in the coming quarters.
Besides balance sheet-specific concerns, economic headwinds add to the stress. CHK stock sentiment is therefore likely to remain bearish amidst multiple negative triggers.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.