Natural gas provider, Chesapeake Energy Corp. (CHK) reported sharper-than-expected adjusted first quarter 2011 earnings of 75 cents per share, striding ahead of the Zacks Consensus Estimate of 70 cents. The outperformance came on the back of a 20% expansion in production volumes. However, the reported figure was below the year-earlier profit of 82 cents.
In the first quarter, the company registered a $725 million loss on energy hedging contracts. Hence, including the hedging loss, Chesapeake posted a net loss of $205 million, or 32 cents a share in the reported quarter compared with a profit of $732 million, or $1.14 per share in the year-ago period.
Total revenue plunged 42% year over year to $1,612 million, and came nowhere near the Zacks Consensus Estimate of $2,653 million.
Operational Performance
Chesapeake’s average daily production in the quarter increased 20% year over year and 6% sequentially to 3.107 billion cubic feet equivalent (Bcfe), of which natural gas accounted for 87%. The percentage of natural gas production to total volume decreased 3% on an annualized basis. However, natural gas production swelled 16% and oil production expanded 56% from the year ago level.
Natural gas equivalent realized price in the reported quarter was $5.99 per thousand cubic feet equivalent (Mcfe) versus $6.80 in the year-earlier quarter. Average realizations for natural gas were $5.31 per Mcf compared with $6.31 per Mcf in the year-earlier quarter. Liquid realizations came in at $63.20 per barrel compared with $67.70 in the year-ago quarter.
On the cost front, production expenses decreased almost 5% from the year-earlier level to 85 cents per Mcfe.
Financials
At the end of the quarter, Chesapeake had a cash balance of $849 million. Debt balance stood at $9,915 million, representing a debt-to-capitalization ratio of 39.8% (versus 45% in the preceding quarter). Cash flow from operations increased 11% year over year to $1,404 million.
Asset Sale Program
The company is on track with its 25/25 plan, aimed at reducing its long-term debt (through monetizing its assets and a reduction of lease-hold spending) by 25% during 2011–2012 while increasing its natural gas and oil production by 25%. The Niobrara Shale co-operation deal with China’s top offshore oil producer CNOOC Limited (CEO) and the sale of its Fayetteville Shale properties to mining giant BHP Billiton (BHP) mark the company’s significant progress in this regard.
Moreover, Chesapeake intends to divest its producing assets in the Mid-Continent through a ten-year volumetric production payment to Barclays PLC’s (BCS) subsidiary for approximately $850 million.
Guidance
The company is guiding toward full-year production growth in the range of 6% to 11% for 2011. Excluding asset sales, the company expects its production to increase in the 17% to 22% range. For 2012, Chesapeakeexpects volume growth in the range of 13–20% and excluding asset sales, it is estimated in the 17–24% range.
Liquids production is expected to range between 32,000 and 36,000 thousand barrels (MBbls) for 2011 and from 51,000 to 57,000 MBbls for 2012. Further, natural gas output is expected to be in the bands of 900 to 930 Bcf for 2011 and 960 to 1,000 Bcf for 2012.
Outlook
We appreciate Chesapeake’s initiative of deploying more funds toward liquids. In the current scenario of an uptrend in oil prices, the company is planning to deploy more capital to drill liquids-rich plays, particularly the unconventional Granite Wash, Eagle Ford Shale, Anadarko Basin, Permian Basin and Rocky Mountain plays. The drilling success rate was 98% for the company-operated wells and 99% for non-operated wells during the quarter.
Given Chesapeake’s industry leading growth profile, competitive cost structure and management’s track record of outperformance, we can easily say that it is favorably placed compared with many of its peers in the exploration and production space. In our opinion, Chesapeake is one of the most active players in the industry to manage its asset portfolio through a combination of acquisitions and disposals.
We think Chesapeake’s focus on shale gas plays should provide the impetus to monetize these assets more effectively. This, coupled with the company’s concentration on liquids will boost returns. However, sincenatural gas accounted for about 87% of Chesapeake’s production in the quarter and given near-term speculations of challenging natural gas fundamentals, we are apprehensive that the company’s results will be vulnerable to fluctuations in the relevant markets. Hence, we believe that the stock will perform in line with the group.
We are maintaining our long-term Neutral recommendation on the stock. Oklahoma City based Chesapeake currently retains a Zacks #3 Rank, which translates into a short-term Hold rating.
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