Chesapeake Energy: Natural Gas or Hot Air?
A couple successful investors likely are partially to thank for holding this stock up where it is, but the weight of its fat-cat leadership and debt-laden balance sheet is substantial.

Alan Armstrong, CEO and Chairman of the Williams Companies (NYSE:WMB), recently suggested at a speaking engagement at the University of Tulsa that falling natural gas prices actually can be good for the country as well as companies — like his — that operate on a large scale. Natural gas has gotten so cheap, it’s one-third the cost of crude oil on an energy-equivalent basis.

Another company looking to take advantage of natural gas is Chesapeake Energy (NYSE:CHK), which is investing $1 billion in the development of a natural gas station network. Excitement over this and other business-related efforts has pushed its stock within 10% of its 52-week high. Momentum investors beware.

Corporate Perks

Chesapeake is legendary for its total contempt of shareholders. Whether it’s the amount spent on corporate jets for top executives, including CEO Aubrey McClendon, or the millions sponsoring the NBA’s Oklahoma City Thunder, McClendon’s personal play toy, shareholder rights are not at the top of its priorities.

If you want a good-paying part-time job, find a way onto Chesapeake’s board of directors. All but one of eight were paid $400,000 or more in 2010. Most impressively, McClendon managed to earn $21 million in 2010 while Chesapeake paid no federal income taxes despite earning $2.8 billion in pre-tax income. The Institute for Policy Studies highlighted the neat trick in a 46-page report on corporate excess issued Wednesday.

In fairness to Chesapeake, the tax break it received wasn’t some special gift from the government but rather the result of $11 billion in non-cash impairment charges to account for lower future cash flows due to declining natural gas prices. Nonetheless, it’s accurate to suggest it pays less in taxes than the average large company. But hey, it does have civic pride.

Balance Sheet

If corporate waste isn’t enough to scare you from owning its stock, perhaps an examination of its balance sheet will. Three things are evident.

First, its long-term debt is substantial. As of the end of the second quarter, it stood at $10 billion, and if you include all its long-term liabilities, that number jumps to $15.4 billion. Shareholders will rightly point out that it underwent a debt-reduction program starting in early 2011 that’s already trimmed $1.98 billion, or 11% of its total long-term liabilities. True enough. However, excluding capitalized interest, it’s paying interest at an average of 6.6% compared to 4.1% for EOG Resources (NYSE:EOG), a similarly sized peer. EOG’s debt load is half of Chesapeake’s.

Secondly, Chesapeake has just $109 million in cash compared to $1.58 billion for EOG. Even if you exclude the $1.39 billion EOG raised from selling 13.6 million shares in March, it still has a better net debt situation.

Lastly, Chesapeake’s current ratio of current assets to current liabilities is 0.55, one-third its rival. You might be able to ignore the corporate excess because the stock has been a good performer of late, but don’t dismiss its balance sheet weakness. It’s for real.

Stock Price

Chesapeake’s stock is up 54% in the past year, and its performance is second-best among the top 10 U.S. independent oil and gas producers. Year-to-date, only Petrohawk Energy — which ceased trading Aug. 26 as a result of BHP Biliton‘s (NYSE:BHP) completed takeover — and Range Resources (NYSE:RRC) have done better. The question is whether CHK can keep it up.

During the past 10 years — with the exception of a huge spike in July 2008, when it hit an all-time high of $74 — it’s spent most of the time between $30 and $40. In 2008, its price-to-sales ratio was 0.8. Today, it’s almost three times that. Two smart investors, T. Boone Pickens and Mason Hawkins, both have big positions in Chesapeake, and that’s likely what’s holding up this stock. If you’re a value investor, EOG Resources appears to be a much stronger play.

Bottom Line

Chesapeake might have some successful investors on board, but that shouldn’t sway you. History suggests this stock is going nowhere fast.

As of this writing, Will Ashworth did not own a position in any of the stocks named here.


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