Chesapeake Energy Corp (NYSE: CHK) has undergone a reorganization and started to deliver on plans to transform the organization into a top tier operator in the E&P sector. Management plans achieve this by more efficiently deploying cash, targeting profitable growth and divesting non-core assets. Chesapeake is exposed some of the best fields and locations under development in Eagle Ford, Utica and Marcellus. The potential is there for it to improve operations, cash flows and increase its returns all of which should translate to EPS growth and multiple expansion over the next few years.
About Chesapeake Energy
Chesapeake Energy Corp is an oil and natural gas exploration and production (E&P) firm. It owns and develops underground reserves of O&G and also provides marketing, midstream, drilling and other oilfield services. All of its operations are located onshore in the continental US. The company has divested assets recently in line with its strategy to sell non-core assets. In October 2012, it sold its Permian Basin assets, and in August 2013, it sold other gas gathering and processing assets to SemGroup Corporation (NYSE: SEMG). Most recently, in January 2014, it completed the sale of subsidiary Chaparral Energy.
Chesapeake is the second largest natural gas producer and 11th largest producer of oil and natural gas liquids. Historically, the stock is heavily tied to trends in the domestic natural gas and the NGL market. Lately, capex has largely focused on liquids versus dry gas to diversify its exposure away from dry natural gas.
The company does not have assets in the much talked about Bakken shale but has a large presence in the Marcellus share and Utica shale regions. A map of its assets is below and includes details on what type of play it is, natural gas or liquids.
Reorganization Focuses on Profitable Growth
Last year the company completed a transformation review and reorganization of operations. It is now focused on new operational processes and cutting costs. It plans a 20% reduction in its E&P workforce. Management has set targets that would make Chesapeake an upper tier operator within the sector. It will drive earnings growth by improving margins, targeting profitable growth and using financial better discipline according to management. For example, it plans to match capex with cash flow from operations, target top-quartile operating and financial metrics and achieve investment grade metrics.
Management plans to focus on value-based versus activity based drilling that can add over $1 billion in PV10 per year. Chesapeake will also further improve the balance sheet by continuing to divest non-core assets. Additional, it expects to increase production in 2014 and beyond by decreasing downtime of drilling and production assets and optimizing current base operations. It will also cut well costs and fixed costs to improve efficiency.
The near-term value drivers are aggressive but achievable as it has already made progress in recent years. As noted it will cut well costs but also focus on reducing cycle time from spud to TIL. Cycle time averaged eight months in 2013 and management has a goal of a 30-60% reduction. Along these lines, it will cut its rig count by 40% y/y and be more efficient with its equipment and crews. It also plans to start using its size to improve purchasing power.
In Eagle Ford, Chesapeake has grown net production by a CAGR of 39% since 1Q11 and has ten rigs operating which it will grow to over 15 rigs in 2014. Helping with its efficiency and cycle reduction targets it plans to improve from 70% of wells being drilled from existing pads to 85% in 2014 in Eagle Ford. Along these lines, in Northern Marcellus, it will move from 65% of well drilled from existing pads to over 80%.
The news that Chesapeake planned to increase the number of platforms to over 15 rigs from 10 and the shift to more on pad drilling at Eagle Ford and Marcellus are both in line with goals of growing and increasing margins. Drilling on pad will cut costs and improve cash flows from those operations. The additional rig counts will allow Chesapeake to increase production at a more rapid rate at Eagle Ford. It plans to cut cycle times there as well all leading to more efficient growth. Eagle Ford will generate one of the highest returns on assets of current regions under development.
Valued at Bottom of Group, Improved Operations can lead to Multiple Expansion
Its peers consist of other diversified E&Ps such as Cabot Oil & Gas (NYSE: COG), Hess (NYSE: HES) and Devon Energy (NYSE: DVN). These stocks trade at 28.5x, 14.7x and 9.8x FY14 earnings. Chesapeake trades at the bottom of the group based on EPS but in the middle of the range based on an EBITDA basis. In terms of price to NTM cash flows, it also trades at the bottom of the range. The other E&Ps generally are considered better operators but if management can execute on its plan, it can command higher multiples for its stock, driving shares higher.
With its geographic exposure and more levers to pull in transforming operations, Chesapeake can achieve better operations and improve earnings. This should translate to earnings growth and multiple expansion which should position Chesapeake to outperform E&P peers.
What are your thoughts on the future of Chesapeake Energy?