Chesapeake Energy Fighting Off Bankruptcy Doesn’t Make It a Buy

Stocks to sell

Yes, 2019 was a rough year for the energy sector. The group saw its weight dwindle in the S&P 500 en route to finishing the year as the worst-performing group in the benchmark. Still, thanks to a late-year rally, the Energy Select Sector SPDR (NYSEARCA:XLE) was able to finish the year higher.

Even After Its Latest Moves, Chesapeake Energy Stock Is Still Too Risky

Source: Casimiro PT /

However, things were much, much worse for natural gas shale producers. Consider the following. The First Trust Natural Gas ETF (NYSEARCA:FCG), an exchange-traded fund that frequently has dog status, lost almost 20% last year, but look good compared to the 60% shed by Chesapeake Energy (NYSE:CHK).

Losing 60% in a year in which the S&P 500 posted its best annual showing in more than two decades alone is disturbing. Even more alarming is that Chesapeake finished the year down by that much even with the benefit of a 38.7% December rally.

Much of the December bullishness was accrued early in the month after Oklahoma-based Chesapeake was able to procure $1.5 billion in financing from a consortium of banks, helping it stave off bankruptcy. Still, some analysts believe that’s no more than a temporary fix and that the capital isn’t a silver bullet for Chesapeake’s deep financial woes.

Awash in Woes

In July 2015, the company slashed its quarterly dividend. Six months later, the company suspended the payout on its preferred shares, contributing to its lower credit ratings. Remember, preferred stocks have bond-like properties and are higher up in the pecking order than common stock in the event of bankruptcy.

In other words, it’s bad when a company cuts or suspends its dividend on its common equity, but it’s much worse when negative payout action comes to preferred stocks. When it revealed that 2015 dividend cut, Chesapeake traded close to $20.

Chesapeake had a $1.7 billion market capitalization as of Jan. 2. However, its debt burden is in excess of $9 billion, or about six times its market value. Additionally, the company is grappling with annual interest expenses of $700 million. That’s almost half its market cap.

So it’s not surprising that Moody’s Investors Service recently lowered a variety of ratings on Chesapeake. What may be surprising is that the shale producer clings to ratings in “B” territory and hasn’t dropped to the highly speculative “CCC” range.

Keep in mind that the company recently engineered a debt swap with bondholders. Those investors received around 57 cents on the dollar for their investments. One need not be a fixed income expert to realize that financially sound companies don’t engage in those type of maneuvers.

Bottom Line: Chesapeake Is Cheap for a Reason

I’m fond of highlighting the potential peril of stocks with low price tags. Even though Chesapeake can offer some near-term upside, the long-term prognosis here is bleak.

With the U.S. awash in oil and natural gas, Chesapeake likely needs something along the lines of oil prices at $60 per barrel and gas at $2.75 per million British thermal units. The former is doable, but Henry Hub gas closed at $2.18 on Dec. 31.

Further vexing Chesapeake is that with natural gas prices low, assets are unattractive to larger oil companies. Many of those big names already enjoy robust gas footprints, so asset sales to raise capital probably aren’t in the cards for Chesapeake over the near term.

There are other points for investors to be aware of. Namely that all of the traditional valuation metrics on Chesapeake are low, implying value. However, the stock’s performance coupled with the controversy surrounding the company likely means it’s more of a value trap.

As of this writing, Todd Shriber did not own any of the aforementioned securities.

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