Natural gas provider, Chesapeake Energy Corp. (CHK) has reported sharper-than-expected adjusted second quarter 2011 earnings of 76 cents per share, striding ahead of the Zacks Consensus Estimate of 72 cents. The outperformance came on the back of a 62% expansion in liquid production volumes. The reported figure showed a modest improvement from the year-earlier profit of 75 cents.
Total revenue surged 65% year over year to $3,318 million from $2,012 million reported in the comparable period last year.
Operational Performance
Chesapeake’s average daily production in the quarter increased 9% year over year to 3.049 billion cubic feet equivalent (Bcfe), of which natural gas accounted for 84%. However, the volume dropped 2% sequentially due to the Fayetteville Shale
assets divestiture. The percentage of natural gas production to total volume decreased 6% on an annualized basis. However, natural gas production grew 3% and oil production expanded 62% from the year-ago level.
Natural gas equivalent realized price in the reported quarter was $6.07 per thousand cubic feet equivalent (Mcfe) versus $6.14 in the year-earlier quarter. Average realizations for natural gas were $5.19 per Mcf compared with $5.66 per Mcf in the year-earlier quarter. Liquids were sold at $65.23 per barrel, up from the year-ago price level of $61.43 per barrel.
On the cost front, production expenses increased almost 12% from the year-earlier level to 94 cents per Mcfe.
Financials
At the end of the quarter, Chesapeake had a cash balance of $109 million. Debt balance stood at $10,047 million, representing a debt-to-capitalization ratio of 39.4% (versus 39.8% in the preceding quarter). Cash flow from operations decreased 7.4% year over year to $1,207 million.
Guidance
Chesapeake has boosted its 2011 as well as 2012 production guidance to approximately 1.170 trillion cubic feet equivalent (Tcfe) and 1.350 Tcfe, respectively, to account for impressive drilling results, particularly in Haynesville and Marcellus Shale plays.
The company now anticipates approximately 30% production growth for the next two years, showing an impressive 20% improvement from its prior forecast of 25% growth rate under its 25/25 Plan.
This year’s liquids production forecast range has been reduced by 2 million barrels (MMBbls), or 6%, to 31–33 MMBbls due to pressures on short-term infrastructure and logistical issues in several of its liquids-rich plays, which the company looks to resolve over the months. Subsequently, the company has also increased the lower end of its 2012 liquids production forecast range by an offsetting 2 MMBbls to 53 MMBbls. Chesapeake expects its natural gas production in the bands of 970–990 billion cubic feet (Bcf) and 1,000–1,400 Bcf for 2011 and 2012, respectively.
We believe that production growth will remain at or near the top of its large-cap peer group, particularly in light of continued strong drilling results from its shale plays.
Capital Budget
The company has raised its drilling budget by $500 million to range between $6.0–$6.5 billion for this year and the next, attributable to higher costs for fracturing well bores and increased drilling in the Utica shale play.
Outlook
Oklahoma-based Chesapeake Energy Corporation is an independent oil and gas company engaged in the acquisition, development, and production of onshore U.S. natural gas resources. The company has grown rapidly and now ranks as the second-largest producer of natural gas.
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 and remains upbeat on particularly its Utica Shale and Mississippian lime plays. During the first half of 2011, the drilling success rate was 98% for the company-operated wells and 99% for non-operated wells.
Chesapeake has leased 1.25 million acres in the Utica Shale, a formation that stretches beneath the Eastern U.S. from Tennessee into Canada. Its acreage in the Utica, which is concentrated in Ohio, may be worth as much as $20 billion. It is planning to enter into a contract with a joint venture partner by the end of 2011. Utica is most likely equivalent, but economically superior to, the Eagle Ford Shale in South Texas.
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, since natural gas accounted for about 84% of Chesapeake’s production in the quarter and as near-term speculations of challenging natural gas fundamentals remain, 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 and maintain our long-term Neutral recommendation for Chesapeake.
The company, which retains a Zacks #3 Rank (short-term Hold rating), competes with EOG Resources Inc (EOG) and Devon Energy (DVN).
