Thursday, April 19, 2012

After Declines, Cheseapeake Equity ($CHK) Now a Screaming Buy

"With projected asset monetization of $10bn - $12bn, the implication is that combined cash and asset sales in 2012 exceed the current fully diluted market capitalization of the company."
I am almost never bullish on equities; buyers of stock are usually chumps. But I have never seen a case where the bears were so wrong.

More on this later.

19 comments:

1ae83750-8a5d-11e1-aead-000bcdcb471e said...

You're overly excited about a poorly managed company. The only way you win on this name is if nat gas goes up. Aubrey is a horrible CEO. Your calculation is incorrect as well since the company's EV is 27B dollars.

CP said...

You don't know what you are talking about. We are comparing CF this year to the current f.d. market cap. Also it's not "my calculation" as that is a quote from s/s research.

"Poorly managed" when the cost basis in a lot of their plays is 0 after JVs and they have an unprecedented track record of hedging gains? Who are you to talk?

Natural gas doesn't need to go up when the company is trading below the value of its liquids production and a ton of peeople are caught short. This is going to be another SHLD.

If the company announced a big buyback this could even be another VW trade. I hate it when bulls say "be careful about your short" - but seriously, I wouldn't want to be short this.

rahul519 said...

i'm not short just so we're clear. I'm just having a healthy debate - there are probably better nat gas names to be long. Aubrey is without a doubt one of the worst capital allocators and corporate governance offenders out there as evidenced by his 2008 blowup, his overspending, and now his Founder's Participation program. Moreover, FCF, not CFO, for this company has been significantly negative for every year of its existence. 2011 saw them generate 100mm of FCF but that was only through the help of working capital adjustments. These assets sales are only the result of Aubrey finding some religion and realizing that his baby is completely and dangerously overlevered. Whether he ultimately succeeds is still to be seen. The cash flow from operations in 2012 may be greater than the market cap but the next logical question is what is the capex number going to be in 2012? Last year that number was 14B and in 2010, 2009, and 2008 it was 13.5B, 7.5B, and 17.7B respectively. So, if we are in agreement that a company is valued on its free cash flows to equity and not on its cash flow from operations, I struggle to see how this stock is a "no brainer." I wish you the best of luck on your long position and I'm sorry if I offended you.

CP said...

It's all good, I'm not offended.

I haven't been long the equity until today. You understand that the FWPP is not new, right? And whether you think it's bad or not (I think it's mixed), at this point the company is an asset play.

Same argument regarding his personal financial decisions.

Do you agree that the company has significantly positive IRR on capex spending?

Have you been reading this blog for long? You know I am almost always a pessimist/bear.

Unknown said...

is this credit bubble or did someone hijack this blog lol... more seriously, i have no position, but am eyeing it as a short on a bounce.

i want to understand the long thesis from someone i respect...

so i will ask once again - is this creditbubble

CP said...

The last time I got this many negative comments was in April last year when I was talking about the silver bubble.

I don't understand what the bearish thesis is. There are any number of assets they could sell and actually take the company private. This is like shorting sears or maybe even the VW trade.

FZ said...

I think if you want to make an asset value case, its probably worth looking at. However with the leverage and maturity profile you are dependent on the credit markets being open. Any hiccup there and this thing is in deep trouble as they will have to burn the furniture (i.e. asset sales) to keep the capital structure from overwhelming the company. Secondly, while long term nat gas price are likely to rise in the short term you could go significantly lower.

CP said...

What are you talking about? There are no significant maturities until 2015. With two asset sales they could pay down all the debt and delever.

wildcat said...

There is no way to look at his track record and not say that Aubrey has been an excellent capital allocator. He may be reckless and spend too much money. You migh even think he is insane, but just about everything he has bought is worth a lot more today than what CHK paid for it. With the JV's he has done, CHK's net cost in most shale plays is zero. He has routinely turned a one billion dollar investment into five billion dollars of value in the space of a year or two (look at the Haynesville, Eagle Ford, or Utica and the JV's he got done there).

One could write a book with accurate and worthwhile criticisms of Aubrey McClendon, but when you say he is "without a doubt one of the worst capital allocators", I am forced to assume you have been looking at the WSJ rather than the company's 10Ks

CP said...

Imagine if he was running it as a PE fund and he could just mark each play wherever he wanted to value it.

1ae83750-8a5d-11e1-aead-000bcdcb471e said...

I'll let this excerpt from a 2009 writeup speak for me. You'll notice that most of the things that have happened since are even more negative than this writeup. Also, the stock is down an additional 33% from 25. Everything becomes a buy at a cheap enough price but CHK isn't worth the headache to me and you're probably better off playing nat gas in some other way.

Chesapeake: At Best A Stock You Never Want To Own

1) The historical performance of this company is terrible, but you'd never know it from listening to management. Aubrey cant open his mouth without talking about "shareholder value creation", although he uses it as nothing more than a hollow catchphrase.

"This singular focus gives us a chance to be the very best in the industry at one thing, and when you can be the best at one thing you have a chance to create increases in shareholder value year after year." - Aubrey McClendon, 2/25/03, Q4 Conference Call

"We are now distinctively positioned to continue reaping the rewards from those timely investments, and to continue delivering top-tier shareholder value for years to come." Aubrey McClendon, 2/23/05, Q4 Conference Call

"I believe you will be very impressed with what we will deliver to you in shareholder value creation in the years to come." - Aubrey McClendon, 10/27/06, Q3 Conference Call

"We don't believe you can find a better combination of great growth and value in the industry and are excited about the shareholder value creation that has occurred to date." - Aubrey McClendon, 5/2/08, Q1 Conference Call

"I believe in what I do for a living; I create value...While this company has had its ups and downs along the way, we have consistently delivered shareholder value over long periods of time and we will continue that in the years ahead...it's there today; you can't see it, but it is there, and it will be recognized over time." - Aubrey McClendon, 6/19/09, Annual Meeting [this one's my favorite]

If Chesapeake has created so much shareholder value, why do they have negative retained earnings? Why is the entire book value of this company paid-in-capital? All of those impairment charges add up...they weren't non-cash when you spent the money. Why has Chesapeake's stock underperformed other large-cap E&P's by 40%, and larger shale-focused companies by 55% in the last 10 years? It's actually the worst performing stock over the last 2, 6 and 12 years among its comp group. Chesapeake trades at the same price today as it did when "Macarena" when the #1 Billboard song (Summer 1996). Why has the debt-adjusted production and reserves per share declined over time? This company has done nothing but destroy value, and I believe they will continue on this path indefinitely.

2) Chesapeake is a chronic issuer of new capital, with little to show for it. In this decade, Chesapeake has sold $10.4 billion in common and preferred stock and raised $12.3 billion in net debt. The shares outstanding have increased over fourfold, from 150 million to 625 million. Against this, Chesapeake has returned $600 million to shareholders via dividends and buybacks. Net capital invested is $23.2 billion. What has all that money bought? How about a PV10 of $7.6 billion, $5-12 billion in unproved acreage, and $4 billion in other stuff. Meanwhile, the company sports an enterprise value of $28.9 billion.

1ae83750-8a5d-11e1-aead-000bcdcb471e said...

Chesapeake had gone on a company/acreage acquisition binge throughout the early/mid 2000's, constantly outspending cash flow. Shareholders were getting fed up with the capital raises even then, so around 2006-2007, after the $2.3 billion acquisition of Columbia Natural Resources, the story about the company changed. Management repeatedly stated that the asset accumulation phase was over, and now was the time to harvest those best-in-class assets and finally watch the per share production/reserve/cash flow metrics take off.

"Nothing else has to work for us. No acquisitions, no stealth plays. We just keep our heads down and keep drilling ahead on the acreage that we own...please recall that now we can deliver all of this value creation without adding debt or increasing our share count." - Aubrey McClendon, 2/15/08, Q4 2007 Conference Call

Net increase in debt since that quote: $2 billion. Net share count increase: 150 million, or 31.5%. This management simply does not know how to run a business without continually diluting shareholders.

3) Aubrey McClendon is a terrible CEO and is single-handedly responsible for Chesapeake's poor performance. He took Chesapeake to the brink of ruin in the late 1990's by levering up the company to go after the Austin Chalk, then getting killed when the Chalk wasn't that good and gas prices plummeted. Last year he almost blew it up again by levering up to buy billions of new leases right before gas prices crashed. And in an event that redefined schadenfreude, Aubrey almost became a household name in 2008 from getting the mother of all margin calls, losing $2 billion and single handedly tanking the stock of his company. He has proven time and time again that he does not understand the concepts of value creation or risk management. The third quarter conference call was particularly enlightening, it gives you a good flavor for what he's like. Among the things he discussed:

2010/2011 reserve guidance assumes that current reserves are merely "temporarily" depressed
2010/2011 reserve guidance was based on what they thought prices will be
Btw, nobody else in the industry gives reserve guidance, let alone on forecasted prices
They consider not paying down debt deleveraging as long as reserves are growing
Note that they ignore the value of those reserves
Aubrey tried his hardest to publicly humiliate every E&P company for not having the same technical capabilities and skill at identifying and acquiring land
Management believes that they themselves are a competitive advantage
Aubrey stated that his hedging "creates" shareholder value whereas competitors' hedging "limits" shareholder value
Despite having only 20% of 2010 gas hedged, Aubrey stated that it "was not possible" that 2010 FCF could be negative
He's notorious for being one of the most promotional CEO's in the industry. I would encourage people to read his opening remarks from the last couple years' conference calls, it's nothing but pure bewilderment over the "value creation" that goes on at the company.

rahul519 said...

4) Chesapeake is one of the least hedged companies in the industry at 22% in 2010...heck, management seems downright proud of this. And with the knockouts and 3-ways they're at risk of losing 50% of that small amount of hedges. The knockouts and 3-ways aren't going to make-or-break the company in 2010, but they certainly wont help. More important is simply that Chesapeake is the most exposed E&P to gas prices next year. This is really the crux of my short argument, because if gas declines, Chesapeake will be the first company to feel it. There's not really much else I can say about this point, it speaks for itself.

5) Chesapeake uses needlessly risky hedging strategies. Last year, management came under quite a bit of fire for their reliance on knockout swaps. Knockout swaps are fake hedges. Chesapeake will enter into a swap and receive a slightly better price than they would with a plain vanilla swap. So if the strip is at $6.00, they'd actually be able to hedge at $6.50. The flipside is that if the underlying falls below a certain price, say $4.00, the whole deal gets called off and the counterparty walks away. This is like getting health insurance that only covers a common cold and ear infection...the whole point is to be covered in case the crap hits the fan. If you're an e&p company, there is no worse product than this, it defeats the entire purpose of hedging. Still, Chesapeake continues to use knockouts for a good portion of their "hedges." 188 bcf (22%) is hedged in 2010 at about $8.50. But 70 bcf of that is with knockouts that vaporize at prices between $5.45-6.75.

Management also uses 3-way collars in addition to the knockouts. A normal collar involves selling a high priced call and buying a lower priced put, typically in a costless transaction. It guarantees the producer will receive a price no lower than the put price, yet no higher than the call price. But Aubrey implements 3-ways which include the extra transaction of selling a put at an even lower price, stretching for a little extra premium. Again, if gas falls below your written put price, you'll find that you're no longer hedged as your written put is now costing you money. 26 bcf of 2010 production is hedged this way, with the puts ranging from $4.25-5.50.

6) Chesapeake uses the most aggressive assumptions when reporting well sizes (EUR's). For example, management uses a 65 year reserve life to model Haynesville EUR's. This is inappropriate, as the oldest Haynesville wells have only been on production for less than two years, and the oldest shale wells have only been around for 6-8 years. Besides being inappropriate it's also irrelevant because it completely ignoring present value. Management's take on this topic provides an example of both their character and judgment of returns.

rahul519 said...

"I have seen a number of other EURs from companies that are at 40 or 45 or 50 years and that actually means that our curves are more conservative, that it takes us 65 to get to say, 6.5 bcfe. So if somebody else is at 6.5 bcfe at 50 years, then it means that we probably have some upside in our EUR over time, if they are getting there in 50 years and our curves take 65 to get there..." - Aubrey McClendon, 8/4/09, Q2 Conference Call

You got that? Aubrey is saying that he's the one being conservative by using the longest well life in the industry. Good grief. But does it even matter? Anyone who knows freshman finance can tell you that whether you want to use 40 years, 50 years or 65 years, the present value difference is negligible in every case and worthless to me today. Using an appropriate discount rate (the industry, for better or worse, clings to 10%...meanwhile, Chesapeake is issuing 10 year debt at 9.5%) anything beyond 30 years has no value at all.

This also highlights one of the big problems in the industry, which is that F&D cost (capex divided by EUR) doesn't tell you much about profitability. F&D doesn't change with the movement of gas prices in the short-term (it will in the long-run as service costs adjust), so it's generally the same whether gas is $10 and the well is insanely profitable or gas is $3 and the well is a money loser. But if you actually model out these wells, including all the extra charges that the companies don't like to report, $6.00 gas is too low for most of these companies to make money.

rahul519 said...

Also, lest we forget, this guy sold his map collection to CHK for $12 million.

There's no real argument to say that he cares about shareholder interests. He's there to make money for himself.

And when all is said and done, if nat gas goes to $7, you'll be rich!

CP said...

I appreciate that, but let's keep the conversation focused.

What value, or confidence interval around a value, do you say the stock is worth?

1ae83750-8a5d-11e1-aead-000bcdcb471e said...

The point I am making is more along the lines of: why bother with this one? There are 10,000 equities out there to choose from and this has a non-zero probability of a total capital loss.

I define my investments first and foremost by what my downside risk is and I can't get comfortable that zero is not a real outcome here. Investors that eventually blow up only look at the potential upside (which in the case of CHK might be 3 or 4x) and then their expected value calculations come up with a 100% upside expectation. That's not prudent.

I am not saying this is a short. I'm saying this is not a buy because of all the red flags.

wildcat said...

I'm not sure where people are getting the idea that this could be a zero from, can someone help me out?

I have yet to speak to a single person who says "this could be an enron" who has actually read the 10Ks or done any real work.

There is no chance this is a zero. There is a non-zero chance of a dilutive equity raise this year if they can't close the hole in their capital budget, but I think that is less than 1%.

I think this is worth 3-4X the current price with years of profitable growth ahead. I have tried to talk to as many "bears" (and I realize most of you have no position) as I can and no one has given me a single fact that I find remotely concerning with regard to the solvency of this company or accuracy of the accounting.

1ae83750-8a5d-11e1-aead-000bcdcb471e said...

And today's news shows where the risk lies... funding gaps - hope you got out of the way.