News Analysis date published New: 
Monday, September 17, 2012 - 13:00
New Date created: 
Monday, September 17, 2012 - 14:04
New Date last updated: 
Monday, September 17, 2012 - 13:00

Is This Hated Stock Finally Ready for a Rebound?

Monday, September 17, 2012 - 1:00pm

During the past few years, we've tracked the ups and downs of Chesapeake Energy (NYSE: CHK). In the summer of 2010, I noted that Chesapeake's CEO, Aubrey McClendon "always swings for the fences."

Trouble is, he has swung and missed more often than not.

McClendon appeared to have a few tricks up his sleeve and was able to boost this stock nearly 50% to more than $30 a share by early 2011. But his attempt at empire building through an aggressive set of asset purchases eventually became his undoing. Earlier this year, he belatedly responded to investors' demands that he shake up the company's board and seek asset sales to lighten the load on an increasingly scary balance sheet.

Such moves were expected to enable this stock to finally rebound and indeed it has perked up a bit in recent months. Investors have come to anticipate a series of asset sales that could finally give fresh support to this beleaguered stock. So when shares prices barely budged on word that the company would sell $6.9 billion in assets, the investor reaction was underwhelming.

A few days ago, I took a quick peek at these moves and concluded that "...analysts are now tasked with figuring out a value for the remaining assets. The tepid investor reaction may be grounds to assume that a figure in the $20s -- and not the $30s -- is what you should be thinking about."

Well, what do the analysts actually have to say? I've found four different views and only one of them could be considered a certifiable bull on this stock. Let's start with the most bearish and work our way up:

UBS' William Featherston says this stock is dead money, as seen by his $19 price target, which is 8% lower than current levels. He notes that Chesapeake didn't get the prices for these assets that many had assumed, highlighting the company's weak bargaining position. Potential buyers knew that Chesapeake needed these deals to be concluded in 2012 because of a current short-term loan that would start to extract much more painful interest rates if it remained unpaid into 2013. His target price of 40% of net asset value (NAV) seems low, but reflects his concerns that the balance sheet isn't truly fixed, only less broken.

Citigroup's Robert Morris isn't much more sanguine with a $20 price target, down 2.6% from recent prices. He has revised his cash flow projections after these asset sales and finds shares to be fully valued at five times his projected 2013 cash flow.

Analysts at Credit Suisse, who maintain their $22 price target, up 10% from current levels, express a different concern: They note that Chesapeake has " abundant inventory of liquids-rich drilling opportunities, but these plays are characterized by higher capital intensity (i.e. will cost more to develop), which creates challenges for CHK given its stretched balance sheet." They also note that shares may continue to be dogged by the fact that Chesapeake still has to sell $3 billion more in assets to meet its targets.

But Chesapeake still has supporters who recognize the fact that the company still has a very impressive asset base. Merrill Lynch's Doug Leggate says the recent asset sales were a more significant event than many realize, as they largely eliminates the chance that Chesapeake will run into major financial distress. More to the point, he says these asset sales will keep going beyond management's formerly-stated goals in order to unlock a great deal of hidden value.

The big chunk of asset sales on Wednesday, Sept. 12, "...underlines management commitment to a harvest strategy that we equate to a break up story, which we believe forces market recognition of under-recognized assets in the portfolio," noted Leggate.

The analyst has taken a fresh look at Chesapeake's remaining asset base along with the cash flow it is capable of producing. By his math, this will be a $35 stock -- or a whopping 75% increase from recent prices -- when more analysts dig deeper into Chesapeake's portfolio. He's an outlier with this view, so clearly Chesapeake has its work cut out to win back the hearts and minds of the investment community.

Risks to Consider: Natural gas and oil prices have firmed up recently, though energy strategists say some of the premium is associated with Middle East tensions, which could eventually abate. If so, then a pullback in these commodities would send shares of Chesapeake back down into the teens.

Action to Take --> This is an interesting dichotomy. Citigroup and Merrill Lynch have looked at the remaining assets -- and the cash flow they can produce -- and have drawn starkly different conclusions. In light of the uninspiring response to investors about asset sales thus far, Chesapeake's board may follow Merrill Lynch's advice and seek further asset sales -- above current targets -- until shares finally respond.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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