Having suffered a 328.59% decrease in profit margin in the latest quarter, the oil and gas titan, Chesapeake Energy Group (NYSE: $CHK) has now filed for Chapter 11 Bankruptcy.
This development makes Chesapeake Energy the largest energy company to collapse following the oil market tumult during the COVID crisis.
Chesapeake Energy was one of the great American natural gas producers of the 2000’s. By 2005 they controlled a large share of the hydraulic fracturing market, second only to Exxon-Mobil in production of natural gas.
However, in the last decade, an excess supply of natural gas caused prices to dwindle and Chesapeake profits to decline.
The abdication of management by founder and former chairman Aubrey McClendon amidst investigations of antitrust violation, only deepened Chesapeake’s decline.
Now in 2020, Chesapeake Energy is in a state of destitution operating with a debt of $9.853 billion and earnings per share of (negative) $-49.97. In additon, to prevent a delisting of its stock from the exchange market, Chesapeake board members approved of a 1 for 200 reverse stock split in mid-April. This move decreased the number of shares outstanding to 9.784 million shares, yet made each of these shares more proportionally valuable.
In a broad sense, Chesapeake is losing a lot of money for stakeholders. With an increase of 122.73% in its debt to assets ratio, will creditors come to alleviate the situation?
Chesapeake is using some of its existing debt to finance its existing $1.1 billion debtor-in-possession loan and further continue operations.
Chesapeake has filed for Chapter 11 bankruptcy; this prompts Chesapeake to reorganize its debt and obligations while still in operation.
According to current CEO Doug Lawler, the company has removed over $20 billion of leverage and financial commitments, but complete restructuring is necessary for future value creation.
To reorganize, Chesapeake has entered into a loan covenant with creditors such as Franklin Resources Inc (NYSE: BEN). This covenant is a condition Chesapeake must obey in order to restructure and refinance itself out of debt; Franklin Resources will take over Chesapeake in exchange for eliminating $7 billion of existing debt.
Despite the shocks Chesapeake received from the COVID pandemic, it is unlikely they will receive a bailout. This is largely in part due to the mixed signals between the Trump administration and prominent energy executives, on whether to use a classical or Keynesian approach when assisting natural gas businesses.
With a history fraught with lawsuits involving antitrust violation and the provision of a faltering commodity such as natural gas, it is likely that Chesapeake Energy will not bounce back from this bankruptcy filing.
Despite the uncertainty of Chesapeake’s emergence from bankruptcy, and a substantial probability of company failure, there could be a benefit to investing in Chesapeake now. Here is why.
Chesapeake is a high risk investment with its substantial debt to assets ratio; a resurgence could definitely mean a high payoff in the end.
Chesapeake also operates at a healthy EBITDA of 5.2474, only a fraction of a point higher than the Oil exploration industry average of 5.14, and well below the market expectation of 10.
A benefit of investing in Chesapeake now is that it’s shares are incredibly cheap at only 5.97 per share.
Furthermore, Chesapeake currently boasts an impressive beta of 1.0036. In other words, the price of Chesapeake’s stock will move with the market; with the impressive resurgence we’ve seen from the stock market, we would be remiss to not acknowledge the potential Chesapeake’s stock has for resurgence as well.
The last tenet is what makes or breaks this investment, and that is how Chesapeake decides to restructure.
As it stands, Chesapeake Energy is the second largest producer of natural gas and the eleventh largest producer of oil. By comparing the prices of the Chesapeake shares against the prices of both crude oil and natural gas futures, we can determine what resource has a greater impact on the company’s performance.
Our regression analysis found no correlation effect between the movement of prices of the Chesapeake share price and that of the oil or natural gas futures. However, there is a greater disparity between Chesapeake and the crude oil futures market as opposed to the natural gas futures market.
Chesapeake Stock price on natural gas futures price regression
Chesapeake Stock price on crude oil futures price regression
Despite there being no correlation between price movements in the Chesapeake stock and the price movements of crude oil or natural gas futures, there is a lot to be said about our measured Durbin-Watson statistic.
The Durbin-Watson statistic measures autocorrelation on a scale from 0 to 4 (0 to 2 for positive autocorrelation and 2 to 4 for negative correlation). A positive autocorrelation suggests that there is a positive correlation in the movement of a security between time intervals – if a stock’s price rose yesterday, it will likely rise again today.
Chesapeake Energy’s stock has a positive autocorrelation with both natural gas and crude oil futures with a Durbin-Watson statistic of less than 2. However, Chesapeake’s Durbin-Watson statistic is lesser when regressed against crude oil futures. This suggests that we are more likely to see Chesapeake’s stock rise when oil futures appreciate as opposed to when natural gas futures appreciate.
It is important to keep in mind, that the sample size of futures was incredibly small, and the time period was narrowed significantly. This means that with a larger sample of futures and a broader time horizon, we could see a correlation between the movement of natural gas futures and the stock price or a greater positive autocorrelation between crude oil futures and the stock.
Nonetheless, a concentration on production of crude oil while sacrificing natural gas would be the most prudent decision for Chesapeake Energy.
Chesapeake has decided to place a greater emphasis on the provision of oil (a wise decision). Note that this decision to push against a reliance on natural gas lowered Chesapeake’s share prices, and the value of the company’s oil and natural gas holdings fell by $700 million in the latest quarter.
If a generation of positive cash flow is produced for Chesapeake’s operations, Chesapeake must primarily focus on oil provision. This could not only increase autocorrelation, but synchronize Chesapeake stock trajectories with crude oil futures. Comparing futures contracts of both Natural Gas and Crude Oil commodities, it is obvious which resource will produce greater prosperity.
The Chicago Mercantile Exchange forecasts an increase in value of Crude Oil shares for the next year, and an opposite trend for natural gas. If Chesapeake Energy massively scales its production of oil, there is potential for a high return on investment.
In conclusion, our advice is to hold on the purchase of this stock, but make sure to keep an eye out for Chesapeake’s restructuring process.