Chesapeake Energy (CHK) management today announced the payment of preferred dividends in cash. Mr. Market remarkably appears to accept this as proof positive of the continuing company financial progress by keeping the preferred stock and bond prices at decent levels. Yet the common stock appears to disagree.
Source: Seeking Alpha Website April 20, 2018 Maybe it is time for the preferred and bondholders to have a good look at the underlying fundamentals shaking up the common shareholders for a dose of reality. Progress is in the eyes of the beholder. So maybe it is time to get together for a far more unanimous assertion as to the current fundamental situation. Source: Chesapeake Energy Fourth Quarter, 2017, Earnings Press Release The market appears to have forgotten that the company lost billions in the previous year. The return to profits in 2017 was accompanied by puny cash flow that could not even cover the capital budget. Therefore, some part of the cash spent on dividends, interest, and capital expenditures was paid for by either property sales as well as more debt. This is not a case where preferred dividends and interest were affordable to the company. Clearly as shown above, the cash flow could not handle either. Therefore the payment of both is definitely not a sign of company health. Instead it is a sign of management valiantly trying to hang onto reasonable credit terms and market acceptance. So far, management has been able to refinance debt and improve the debt profile tremendously. But the common price action may be the beginning of the end of this strategy. The market appears to be heading towards a new reality that may increase the forward challenges for management. If that is the case, it may turn out to be bad news for both bondholders and preferred stockholders as well as common shareholders. Source: Chesapeake Energy March, 2018, Scotia Howard Weil Energy Conference Slide Presentation The whole problem can be neatly summarized above. Despite all the ballyhooed progress management has made involving the gas operations (or any operations for that matter), legitimate free cash flow remains elusive. Not only is free cash flow elusive, but sufficient cash flow to service the debt has been delayed by weakening gas prices. Gas production appears to be in overdrive as a consequence of increasing oil production. Investors can probably blame rising oil prices for the rapidly expanding supply of gas in the face of weak gas prices. Management is running hard to keep the operational improvements ahead of the weakening gas prices. The first slide does show some cash flow progress with the expectation of more cash flow progress this year. But the market appears tiring of the delay of obtaining sufficient cash flow. It is not unusual to post earnings after years of impairment charges and losses. All that is necessary for earnings is a very conservative impairment charge reporting strategy followed by an aggressive (but GAAP approved) routine reporting strategy. Of those two the conservative impairment reporting strategy is by far the most important. The more conservative the impairment charges, the more likely that profits will be reported in the near future. Source: Chesapeake Energy March, 2018, Scotia Howard Weil Energy Conference Slide Presentation The company financial strain shows in the company presentation. Despite the improvements in production shown above, the management is opting to maintain production. Clearly, management needs to grow production considerably to escape the debt stranglehold on the company finances. Yet as shown above, the best that management can accomplish is production maintenance. Oil production in particular should be coveted enough until production increases of oil are a high priority. Yet that does not appear to be the case for the Eagle Ford as shown above. Overall production growth, if any, will not be sufficient to change the overall financial health picture. The common stock appears to be responding to this reality. There is every chance that management should suspend the preferred dividends regardless of the consequences to drill more oil wells. All the equities would benefit from this strategy. Source: Chesapeake Energy March, 2018, Scotia Howard Weil Energy Conference Slide Presentation The cash flow from operations (the GAAP measure) is projected to be insufficient yet again to properly service the debt. Not much debt is currently due. However, the company does have a negative working capital balance and will need the current property sales to fill the gap between budgeted expenditures and cash flow from operations. The roughly $ 10 billion debt balance was probably not decrease materially even with the property sales. Oil prices have definitely rallied to some decent price levels. But there are far too many projects that can breakeven at far lower prices for oil prices to stay at current levels or higher for more than a year. That is probably not enough time for this company to resolve its financial challenges. The common stock may be reflecting the dim financial outlook of the company. Maybe it is time for the other securities to pay attention. Buy and hold investors may want to avoid all the securities of this company until the current situation resolves itself. There is far safer preferred stocks and bond investments than Chesapeake Energy. Management has done very well to achieve the progress made. But that progress does not represent an investment opportunity. Disciplined traders may yet have some trading opportunities in the securities of Chesapeake Energy. But the company securities are far too dangerous for a buy and hold strategy. Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications. 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.
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