Saturday, February 25, 2006

Chesapeake Energy (CHK) Updated Analysis

In the prior article we analyzed Chesapeake energy balance sheets and potential for this quarter. Chesapeake Energy announced its fourth quarter earnings last week. We will update the analysis after the fourth quarter results to see how Chesapeake looks like.

We will divide this article into two parts. First - a look at the fourth quarter earnings ( we can't analyze the earnings as the 10-Q is not filed ) and the second part which will analyze the future outlook.

The company beat the analyst estimates and earned $2.51/share for 2005. The stock market is driven primarily by the rosy future as opposed to the rosy past. So, let us take a look at Chesapeake. The fools have also analyzed and are bullish about this stock.

The analysts think highly of the stock with a median recommended price target of $41=00. The low price target is $35=00 and the high target is $49. The EPS estimate by analysts for 2006 is 3.49 with a decline in 2007. The increase in 2006 revenues is about 40%. The analysts are expecting the earnings to go up by about 80% this year compared to last. The 2007 outlook is not very clear yet. However, the company is growing organically and through acquisitions quite rapidly and expect it to continue to grow at a quick pace. The current P/E for the company is 12, taking into account dilution and other factors, the price target of $40=00 remains highly likely for this stock. ( 3.5 x 12 == 42 ). The P/E is likely not expand anytime soon. The company's EPS will likely be higher than 3.5 this year because of hedging. It will likely contract in 2007 as the market expects lower prices for oil and natural gas.

The daily production of natural gas increased by 35% in 2004 from 2003. It increased by 29.5% in 2005 compared to 2004. It is expected to increase in the 25-28% range in 2006. The company is expecting the prices of natural gas to be $9.47 in 3/31/06, $7.91 by 12/31/2006 and $7 by 12/31/2007. The prices are oil are expected to be $58, $54 and $50 respectively in the same time period. As we know, the prices of natural gas and oil are subject to fluctuations and are not driven by the suppy/demand equation alone. The middle east, africa and south american politics not all of which are friendly to the U.S are helping the fluctuation in prices.

Interestingly enough, management doesnt think there would be considerable dilution in stocks till 7/31/2007. The percentage dilution by 12/31/2007 as projected in February 2006 is about 20%. The company has hedged 71% of 2006 production at $9.49/mcf, 31% of 2007 production at $9.91/mcf and the 20% of 2008 production at $9.1/mcf. This looks like a good deal considering the price of natural gas at the moment. The oil production is also similarly hedged with 63%, 22% and 14% of the production being hedged at $61, $62 and $65 dollars per barrel respectively.

Although the price of natural gas has fallen from its peaks, oil continues to be volatile. The volatility is primarily because of the politics in the middle east. Chesapeake owns it natural gas resources in the U.S and has very little foreign exposure. Management outlook for the company is also positive as noted in the press release.
Our business strategy features delivering growth through a balance of acquisitions and organic drilling, focusing on natural gas to take advantage of strong long- term natural gas supply/demand fundamentals, building dominant regional scale to achieve low operating costs and high returns on capital and successfully mitigating risk through the opportunistic hedging of commodity prices and service costs. We believe Chesapeake's management team can continue the successful execution of the company's distinctive business strategy and continue to deliver significant investor value for years to come

The stock definitely has an upside - a twenty percent appreciation definitely looks possible in the next couple of years. The main worry for this stock is the price of natural gas. Fluctuations in the price of natural gas will drive the price of this stock irrespective of the fundamentals.

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