Can Chesapeake Energy Thrive Under a New CEO?

Chesapeake Energy’s (NYSE:CHK) stock has surged 18 percent since January 28 — the day Aubrey McClendon announced he would step down as CEO. With a new management team at the helm, the company is focusing on stabilizing its natural gas operations, which have struggled owing to an oversupply of natural gas, and reducing the amount of debt on its balance sheet.

Is Chesapeake Energy on a sustainable path to profitability? Let’s use our CHEAT SHEET investing framework to decide whether Chesapeake Energy is an OUTPERFORM, WAIT AND SEE, or STAY AWAY.

C = Catalysts for the Stock’s Movement

Clearly, investors responded positively to the news of Aubrey McClendon’s departure, but what exactly were they celebrating? McClendon faced pressure to leave largely due to unsavory allegations arising from his involvement. Under his guidance, the company became the second-leading producer of natural gas in the U.S. While the company holds many attractive properties for unconventional gas and oil plays, its capital expenditures and drilling costs have consistently outstripped its cash flow. This was largely due to McClendon’s willingness to pay high premiums for attractive oil fields.

Under new CEO Doug Lawler, Chesapeake Energy is focusing on strengthening its balance sheet — namely, reducing the $12 billion of debt on its books. To do this, the company recently announced that it is selling portions of its Haynesville and Eagle Ford shale fields, for a total selling price of $1 billion.

While the company will lose some production capabilities from the sale, it will not have to take on additional debt to run its operations for the rest of the year. New management has committed to avoiding land sales to fund operations in the future, and instead is focusing on creating net positive cash flows by compressing its leasing operations, and focusing on higher-yielding extraction operations.

E = Earnings are Mostly Increasing Year-over-year 

Chesapeake Energy announced solid first quarter earnings back in May. The company reported a 67 percent increase in net income from the previous year’s quarterly net income. Additionally, total oil production increased by 9 percent on a year-over-year basis.

Depressed U.S. natural gas prices continue to hold back the company’s top line, but these prices look to be improving. The price of West Texas Intermediate crude oil surpassed the price of Brent crude oil — a benchmark for international oil prices — on Friday.

2013 Q1 2012 Q4 2012 Q3 2012 Q2 2012 Q1
Qtrly. EPS $0.02 $0.04 -$3.19 1.29 -$0.11
EPS Growth YoY 118.18% -29.94% -359.35% 89.71% 65.63%
Qtrly. Revenue $3.24B $3.54B $2.97B $3.39B $2.42B
Revenue Growth YoY 41.55% 29.74% -25.32% 2.14% 50.06%

*Data sourced from YCharts

S = Support is Provided by Institutional Investors and Insiders

Chesapeake Energy has experienced strong support from “smart money.” Two institutional giants, Carl Icahn and Southeastern Asset Management, hold large stakes in the company. Icahn increased his holding from 7.6 percent of his total portfolio, to 8.9 percent of the company late last year. Additionally, Southeastern Asset Management’s Mason Hawkins owns a 13.5 percent stake in the company. With a track record of investing in successful companies, Icahn and Hawkins clearly see growth potential in Chesapeake Energy.

Insiders are bullish on their company, as well. Insider buying activity has increased drastically in the past three months. The most notable of these trades was a 450,000 share purchase by Director Archie Dunham on May 22. The number of shares bought by insiders has exceeded the number of shares sold by insiders tenfold in the past three months. If the people that know the company the best are buying, investors should take it as a sign that the stock is poised for growth.

T = Technicals on the Stock Chart are Strong

Chesapeake Energy is currently trading around $22.31, above both its 200-day moving average of $20.11, and its 50-day moving average of $21.17. The stock has experienced a strong uptrend in the past year — rising almost 30 percent in the last 12 months.

Currently, Chesapeake Energy has a RSI (relative strength index) number over 80, implying that the stock is overbought in the short-term, and could be poised for a pullback. The stock is trading about 3 percent below its 52-week high of $22.97, which was hit at the beginning of March.

Conclusion

As the second-leading domestic natural gas producer, Chesapeake Energy is certainly a company to consider if you are bullish on the energy renaissance in the United States. Chesapeake Energy has the greatest exposure to unconventional oil plays, and has a history of selecting profitable projects, such as its holdings in the Eagle Ford Shale in Texas, and in the Utica Shale in Ohio.

However, because of high capital expenditures and drilling costs, the company has failed to generate net positive free cash flows in the last eight years. The company will need to find another way to strengthen its balance sheet, rather than selling off parts of its oil fields. Until the company’s new management can demonstrate sustainable positive cash flows and earnings, Chesapeake Energy is a WAIT AND SEE.

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