Chesapeake Energy Corp. (CHK) reported sharper-than-expected third quarter earnings of 70 cents per share, well above the Zacks Consensus Estimate of 65 cents. Earnings came in above our expectations due to a whopping 23% increase in production volumes and higher prices. However, the reported figure remains flat with the year-earlier level.
Total revenue increased more than 45% year over year to $2,581 million, exceeding the Zacks Consensus Estimate of $2,318 million.
Operational Performance
Chesapeake’s average daily production in the quarter increased more than 22% year over year and 9% sequentially to 3.04 billion cubic feet equivalent (Bcfe), of which natural gas was 90%. The percentage of natural gas production to total volume decreased 2% on an annualized basis. Importantly, the percentage of revenue from liquids was 17% of realized production revenue compared with 14% in the year-earlier quarter.
Natural gas equivalent realized price in the reported quarter was $5.67 per thousand cubic feet (Mcfe) versus $6.44 in the year-earlier quarter. Average realizations for natural gas were $5.20 per Mcf compared with $6.04 per Mcf in the year-earlier quarter. Realizations came in at $59.81 per barrel of liquids compared with $66.42 per barrel in the year-ago quarter.
On the cost front, production expenses reduced more than 13% from the year-earlier level to 83 cents per Mcfe. Cash flow from operations decreased 4.3% year over year to $1.07 billion.
At the end of the quarter, Chesapeake had cash balance of $609 million. Debt balance stood at $11.45 billion, representing a debt-to-capitalization ratio of 42.8%.
Outlook
The company is guiding toward full-year production growth of 13%, and 18% for both 2011 and 2012. Although the company’s production profile is fairly natural gas weighted, approximately 60% of this year’s growth is expected to come from increased liquids production. For 2011 and 2012, liquids production is expected to be 80% and 60%, respectively.
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 99% for company-operated wells and 98% for non-operated wells in the first three quarters of 2010.
Given Chesapeake’s industry leading growth profile, competitive cost structure and management’s track record of outperformance, the company is favorably placed compared with many of its peers in the Exploration and Production space. The company also plans to sell a 25% interest in the Anschutz Marcellus purchase. Additionally, the company plans to include the remaining 75% of Anschutz assets in another joint venture (JV) in the first half of 2011. Chesapeake has initiated JV efforts for its 800,000 net acres in the DJ and Power River Basins. Including the CNOOC Eagle Ford Shale JV, the company has raised approximately $4.1 billion from asset sales so far in 2010.
We think Chesapeake’s concentrated focus on shale gas plays should provide the impetus to monetize these assets more effectively. This, coupled with the company’s increased focus on liquids will boost returns. However, given our outlook for challenging natural gas fundamentals in 2010, we believe that the stock will perform in line with the group.
We are currently maintaining our long-term Neutral recommendation on Chesapeake shares. The company holds a Zacks #3 Rank (short-term Hold rating).
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