Tuesday, December 27, 2005

Chesapeake Energy (CHK) Analysis

CHK or Chesapeake Energy has recently been in the news because of heavy insider buying. The CEO and COO have bought shares to the tune of $19 million dollars. Let us quickly look at the balance sheets to see how things look up for Chesapeake Energy and if the stock is a buy.

Chesapeake Energy is increasing the production of natural gas at the rate of about 5% per quarter. If oil and natural gas prices hold steady, this should lead to better revenues and profits. For the forth quarter of FY05, Chesapeake seems to be well positioned. From their third quarter earning report - it shoes that they have hedged 55% oil at 54.97/barrel and 77% of natural gas at 8.14/mcf. The fourth quarter of FY05 is now pretty much over and much of the debate is how the prices would hold up in the new year. It is unlikely that prices will drop below the hedged prices anytime soon inspite of the weather reports.

The revenues for Chesapeake Energy increased ~3% quarter over quarter from second to the third quarter of FY05. If this trend holds up, one may be looking at 10-15% growth in revenues for FY06. If the company is able to improve productions and the sales price remains the same or higher, one can expect some upside surprise in the stock.

The tempering factor for the stock are a couple of factors. First the volatility of energy prices, particularly natural gas prices. The second factor is the conversion of long term debt into common stock. The company has consistently issued common stock to take debt off from its balance sheet. The quarterly report shows that this trend will continue to improve the balance sheet. A cleaner balance sheet allows the company to borrow for infrastructue or growth needs more easily.

However, the trend to issue new stock must be balanced against the current market situation. At present the stock has done well although it is well off its 2005 peaks. Continued weakness in the stock will impede the management team from pursuing the policy of issuing stock to remove debt from the balance sheets.

Overall, this company has a strong growth track record and the management has focussed on execution. Management also believes that natural gas prices will continue to remain solid for the next five years. Management buying may be to maintain the percentage ownership of the company. Currently McClendon owns about 5.7% of the company and Ward owns about 3% of the company. The fourth quarter is definitely strong for CHK and if the gas prices hold up, FY06 will also be strong.

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