A few years ago Chesapeake Energy was one of the market's hottest stocks. From 2003 until its peak in 2008, the company's shares, fueled by a rise in natural gas, went up by more than 700%. Since its peak in July of 2008 shares are off by nearly 70%. With so many investors being burned over the past five years, no wonder the company is hated by investors.
That hate has turned some investors to actively bet against the company's future success. At last count, 13.5% of its outstanding shares were sold short. While the short interest is down slightly from the end of last year, investors still hate this stock. Are these investors too focused on the past to miss a potentially exciting future?
Why it's hated
I'll be honest with you, there are some good reasons to hate this stock. Under the leadership of CEO Aubrey McClendon the company has undergone an ambitious growth phase which enabled it to become the nation's No. 2 natural gas producer. The problem here is that its growth came at a great cost as the company took on massive amounts of debt. With the plunge in natural gas prices, the company is having trouble managing this heavy debt load while also investing to grow.
In order to fund its capital expenditures Chesapeake has turned to selling off assets to make ends meet. Last year the company sold its interest in Access Midstream Partners , along with a host of other assets, in an effort to raise billions in cash. Chesapeake is planning to sell $4 billion-$7 billion more in assets in the year ahead. It already sold a portion of its Mississippian Lime acreage to a Chinese national oil company and has put its stake in Clean Energy Fuels up for sale. The concern here is that the company's precarious debt position is forcing it to sell these assets at fire-sale prices.
While the company labels these sales as non-core, the assets are top-notch. Access Midstream for example is a stable, low-risk, cash flow asset. Clean Energy just happens to be the company behind America's Natural Gas Highway and is helping to spur the growth of natural gas demand. For investors shorting the stock, they see a debt-laden company that needs to sell excellent assets in hopes that those asset it keeps turn out to be worth more in the long run.
Why it should be loved
Now, with that out of the way, let's get to why you'd want to buy this company. Chesapeake is an emerging liquids story and is now the 11th largest liquids producer in the country, and is aiming to grow that production by 27% this year to a total of 26% of its production. As you can see in the map below, Chesapeake has acreage positions in most of the top onshore plays, positioning it to continue to grow its liquids production:
There are two other key points to Chesapeake's future that I think investors shorting the stock are missing. First, McClendon, the man responsible for a lot of the company's bad publicity and debt-fueled growth is retiring. While the new CEO has a big task in turning around the company, the assets are all in place, so the focus will be on execution.
Finally, there is massive upside if the price of natural gas begins to rise. While natural gas is 77% of its current production, it only makes up 23% of the company's revenue. For example, a rise in the price of natural gas from $4-$5 this year would increase earnings by more than 30%. Given that most drillers are holding back on dry gas drilling, at some point the price of gas will start to creep higher; when it does, it'll provide a big boost to Chesapeake's shares.
My Foolish Take
Personally, I don't think shorting Chesapeake's shares is a good idea. If the new CEO can provide stability and lead the company to execute on its liquids growth plan then the company should be in pretty good shape. Further upside is possible if natural gas prices begin to head higher. Once that happens, investors shorting this company will regret that decision.
These are just some of the reasons why I think energy investors would be hard-pressed to find another company trading at a deeper discount than Chesapeake Energy. Its share price depreciated after all of the negative news surfaced concerning the company's management and spiraling debt picture. While the debt issues still persist, giant steps have been taken to help mitigate the problems. To learn more about Chesapeake and its enormous potential, you're invited to check out The Motley Fool's brand-new premium report on the company. Simply click here now to access your copy.
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