Chesapeake Energy Delivers Again

The chart above hardly looks like a company that has been clicking on all cylinders for the last 12 months. However, it serves as an example for investors that short-term stock movements oftentimes do not reflect the true fundamentals at publicly traded companies. Shares of Chesapeake Energy (CHK), as you can see, have been moving sideways for a year.

It is interesting to note, however, that CHK management has been doing an exceptional job at creating value for shareholders. During this time, Chesapeake’s book value has risen by more than 140 percent, from $4.2 billion on 9/30/05 to $10.2 billion on 9/30/06. The company’s public enterprise value, though, has only risen by about 10 percent during that time, leaving one to conclude that the stock price has a lot of catching up to do in coming months.

Note: the stock price has dropped slightly over the last year, but the enterprise value of the company has risen due to share count dilution, both from the issuance of convertible preferred stock and additional equity used to fund CHK’s expansion.

Chesapeake reported another excellent quarter last night, as Q3 earnings hit $0.83, 11 cents above consensus estimates and 3 cents higher than the most bullish projection on the Street. Revenue hit $1.93 billion for the period, versus estimates of $1.47 billion. Most impressive of all, CHK raised its production growth targets for 2007 and 2008, from 11% and 6%, to 16% and 12%, respectively.

Wall Street analysts are currently projecting Chesapeake’s earnings in 2007 to be flat, followed by a drop in 2008. However, given the production growth that the company seems comfortable in forecasting, natural gas prices would have to fall meaningfully for such an outlook to prove accurate. I suspect that Wall Street is overly pessimistic about Chesapeake’s earnings power over the next couple of years (and beyond). As a result, I would not expect the stock to continue to trade sideways indefinitely, as it has for the last 12 months.

Full Disclosure: I own shares of Chesapeake Energy (CHK) personally, as do my clients.

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7 Thoughts on “Chesapeake Energy Delivers Again

  1. CHK has been a great performing stock that has benefited greatly from increased natural gas prices over the past several years. however, i would add one caveat to your post: for oil and gas producers, book value is not a good indicator of enterprise value. book value only indicates how much capital has been deployed, but doesn’t tell the analyst how effectively that capital was invested. consequently, a 140% increase in book value doesn’t necessarily indicate a similar increase in overall profitably or value of the enterprise. on the other hand, if you believe that CHK has been, and should continue to be a good steward of its capital, then you would expect to see results associated with that investment activity that are accretive to shareholders.

  2. Chad Brand on October 29, 2006 at 3:47 PM said:

    Well, I’m going to have to respectfully disagree. An increase in book value (as long as it is tangible value and not goodwill/intangible value) most definitely implies an increase in the value of the entire enterprise. Book value represents the net value of the company’s assets. That is crucial in valuing a company. It is true that premiums to book value are assigned to most publcly traded by the markets, and are in part based on investors’ confidence in management’s ability to invest capital wisely in the future. However, if CHK’s book value increases consistently, it surely must affect one’s valuation of the company. What multiple you assign to that asset value is in the eyes of the investor and up for debate.

  3. my comment is with respect to oil and gas producers, especially those like CHK who use the full cost accounting method. under full cost accounting an oil and gas producer capitalizes (e.g., adds to its total assets) all capital expenditures at cost regardless of whether they are successful or not. so, in an extreme example, a company could drill wells that are not profitable, but the cost of those wells would increase the book value of the company. additionally, a company could aquire properties and pay a price far in excess of what they are worth and that acquisition would increase the book value of the company. in either of these instances, the book value would increase, but it would not indicate how the economic value of the firm was impacted. on the other hand, if the company drilled some incredibly profitable wells or made a great acquisition of assets, the book value would greatly underestimate the value of the firm.

  4. Chad Brand on October 31, 2006 at 9:35 AM said:

    I would agree that solely looking at book value, and not the overall profitability of the firm, would be shortsighted. However, in CHK’s case, the company’s drilling programs have been wildly successful.

  5. what makes you say that CHK has had a “wildly successful” drilling program? i’m curious because i have been bearish (and very wrong, i might add) about CHK for several years. primarily, because they have a relatively high full cycle cost of production (2005 was $3.76/mcfe) and a reputation in the industry as a company that overpays for acquisitions. any color that you have would be appreciated.

  6. Chad Brand on October 31, 2006 at 1:24 PM said:

    While they are one of the most active acquirers in the industry, I don’t think they have overpaid. Perhaps the competition labels them such after missing out on landing properties they would like to have. The deals are accretive and their margins on acquired production are very strong. Cost per mcfe of acquired gas in 2005 and 2006 has been $2.43 and $2.50 per unit, respectively. Realized prices for this gas was $6.90 and $8.77 per unit… very attractive margins. The futures curve has gas prices pegged between $7 and $8 through 2010, so CHK will likely remain the most active hedger of their gas. If they can acquire gas for $2.50 and sell it for $7.50, it’s hard to argue against it. And of course, margins on organic drilling are a lot higher.

    Production growth and proved reserve growth at CHK have been among the best in the industry. Current organic production growth is projected at 16% in 2007 and 12% in 2008. Proved reserves are expected to increase from 8.4 tcfe today to 11.0 tcfe by year-end 2008. These types of numbers, and the income that has been/will be generated, I think shows how well the company is doing, both by drilling existing properties and acquiring new ones. CHK continues to climb the list of largest U.S. producers and are the number one driller in the country today.

  7. David Hopkins on November 1, 2006 at 1:54 PM said:

    Also, don’t disount the very aggressive insider buying by Mr. McClendon. It is not out of the question for this company to eventually be taken private a la Kinder Morgan. Shareholders would be rewarded nicely in all liklihood if that were to happen.

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