Chesapeake Energy Shows Fragility of Oil Business

Chesapeake Energy

Once a dominant player in the oil and gas business, Chesapeake Energy is now barely breathing, with their stock now down 99.9% since 2008 and their market cap down to $129 million.

This is not Chesapeake Energy’s first rodeo, as they have taken some very big falls before, almost losing their life, but this time they may not get back on their feet. The oil and gas business has been horrible the last few years, and everyone’s gotten hurt, but few more than Chesapeake Energy has.

Chesapeake Energy was already in serious enough trouble before this latest 6-year bear market in energy stocks, as their problems go back much further than that, to the early days when they borrowed far more money than it would have been wise to in their efforts to grow the company as fast as they could.

Their journey has included some very big boom times as well as the huge busts, and this has not been a stock that has been in any sense tame. If we were looking for a stock to show the importance of timing your investments, it would be hard to find a better example than this one, not just because of the way it has crashed, but also the way it has exploded to the upside at various times.

Chesapeake Energy was born in 1989 with an initial investment of $50,000, and by 1993, they had grown enough to offer their shares to the public. A year later, their stock had lost half its value, which may seem like a big loss but was a very small move in comparison to what was to come.

The company has always taken the strategy of seeking maximum leverage to grow as much as possible, and when you are in the oil and gas business where you are subject to such extreme fluctuations in price, this is the perfect recipe for a boom or bust situation, and Chesapeake Energy has seen plenty of both on a monumental scale.

From 1994 to 1996, the stock grew by 61 times, turning that 50% loss into just a mere blip on their chart. By the time 1999 came, they had given it all back and were now well below their IPO price once again.

From 1999 to 2008, they saw their stock price grow this time by 100-fold, doubling the previous all-time high set in 1996. At the right time, this stock produced mind-boggling returns for their investors, and if an average return of 1400% per year over 7 years doesn’t make you happy, nothing will.

Given that this stock goes down just as fast, a buy and hold approach with this one certainly won’t do, and if you had bought the stock when it first hit the street as an IPO back in 1993, all you would have to show for this over these 27 years would be a 95% loss.

Since the highs of 2008, Chesapeake Energy stock has lost a cool 99.9% of its value, and had to do a 200:1 reverse stock split just to get their stock up to the around $12 a share that it is now and avoid it being delisted. This may not work to prevent this as things are about to get worse, with the expectation that they will declare bankruptcy in the coming days, already defaulting on one interest payment with lots more of that in store.

A lot of bankruptcies are survivable, where companies simply need to reorganize and reduce the burden that they are under to allow them to better cope with the market with a business model that otherwise may be fine if not for their high debt loads. Chesapeake Energy’s situation is about as grim as they come though, unbelievably grim in fact.

You don’t see companies with quarterly losses that exceed a stock’s market capitalization, meaning that they lost more money just in the first quarter of this year than their entire stock is worth. It is estimated that they will lose a further $25 a share in the second quarter, and the stock only trades at half of this. This means that you can pay $12 a share for it and lose $25 just in one quarter of ownership, which is indicative of a ship that is headed for the bottom of the sea, and fast.

When you add in near-term expected losses of $27.50 per share in Q3, $22.57 in Q4, and $33.26 in Q1 2021, this is like someone being shot several times after they are likely dead. When, on top of this, you owe more money than the sum total of all your reserves, where even if they could magically be delivered to market with no cost and sold you’d still be sunk, and you simply cannot add to these reserves, it is near impossible to imagine this not being a death sentence.

Trying to Grow Too Fast in the Energy Business Can Eventually be Deadly

The company barely escaped bankruptcy four years ago, but it seems inevitable now, and bankruptcy here just won’t mean reorganization. This is the real deal, where you can’t pay your debts now, nor are you positioned to survive very long even with bankruptcy protection. You can’t just keep losing money like this, as when your losses are big and you can no longer borrow to stay afloat, you don’t stay afloat.

Chesapeake Energy’s story is one of over aggressiveness, going back even further than the massive decline that they suffered in 2008, where over a very ugly 5 months in the second half of the year the stock plummeted by 85%.

The company had already been borrowing and spending like crazy, and after this huge market-based hit that they were singled out for a lot more additional punishment due to their alarming balance sheet, they just kept doing it. By 2012, they had racked up $16 billion in debt, a truly alarming number for a company of this size, and the board had to step in and fire their CEO and put together a plan to try to get out of this colossal mess.

When you’ve gone this far into the red, the only solution is to sell off assets to try to pay this back, which took them from being the country’s second biggest natural gas producer to one with a significantly smaller footprint. They did manage to knock down the bill to $10 billion by the time that the big downturn in the natural gas market of 2014 to early 2016 hit, but this had left the company in such a weakened state that they barely fended off bankruptcy and had to engage in some creative debt swaps to stay in business.

In spite of the way that oil and gas companies have tanked over these last 6 years, both commodities have traded pretty flat until recently. When we look at how poorly the energy sector has done up until recently, this hasn’t been asset prices that have continued to drive them down, and both oil and gas have just recently taken out their early 2016 lows.

Chesapeake Energy didn’t need to wait until COVID-19 hit to be put in intensive care though and from April of 2019 to late February of this year, when the stock market started to crash over worries of the pandemic, Chesapeake Energy was already on the ropes fighting for their life and had already lost 95% at this point over this short period of time.

Over the last few years, the company had moved away from natural gas and into the oil business more and more, thinking that this was their way out, but this has just added to their problems as oil prices plunged. The stock is down 85% from February, as an incredibly ugly story was made all the uglier due to the recent collapse in energy prices.

Oil has higher profit margins and had the price not declined the way it did, they were planning on using this as a way to continue to fight on. Things didn’t quite work out that way. It’s not even that they were counting on profits from this, they were instead looking forward to selling off another $200-$300 million worth of assets to keep the wolves away from the door. The value of these assets plummeted as well, leaving the wolves not fed enough and howling even more loudly at their door, and about to break it in.

This Stock Deserves a Sell Rating Like No Other

You don’t see analysts give sell ratings all that often, are only reserved for the direst of stocks. They are unashamed generally of maintaining a hold rating in the face of some pretty massive declines, but there is a limit to this, and they do dig out sell ratings for the worst of them.

The average rating among the analysts that follow Chesapeake Energy is Sell, but CFRA analyst Paige Meyer has dug deep in her drawer and pulled out a Strong Sell recommendation, with a price target of $0. That’s truly filling out the death certificate on them as they lay dying.

This is one case where the fundamentals that Meyers cites as her reasons for this grimmest of outlooks is extremely likely to be fatal. Stocks don’t just bounce off of zero, this is what happens when things simply end and people throw their stocks on the floor like losers at horse racing tracks do. This is what she sees happening, and the chances of this happening are extremely high.

Even the most eager of beavers who might want to play a potential bounce with this stock need to exercise extreme caution, which means steering well clear of this play right now as the company figures out what it is going to do. When you hear that a company is very likely to declare bankruptcy in a few days, this is not a stock we should ever want to be in.

We had no problem putting on a little play with Hertz the day after they declared bankruptcy, but these situations are completely different as Hertz’ infection was only temporary and one that they will probably be able to resolve fairly soon, with the bankruptcy providing a helping hand to get them over what has them sick in bed right now.

Chesapeake Energy’s affliction looks terminal though, and the terminal may not even be that far away. Some companies survive and flourish after a bankruptcy filing, but if there ever was one that we could probably not say this about, this is the one.

The sheer amount of selling that this stock has been hit with over the last 12 years does speak to the number of people who did get out, although there’s always someone there to take it off your hands provided that the stock keeps trading. Both parties got stung with this, those who fled and those who took this horrid stock off their hands.

What happened to those who actually had the idea that buying this was a good idea over this time is what is particularly notable about this is the risk that you take catching falling knives, and like those who have owned it prior to a big blow-up and insist on hanging on to it commit this mistake as well, and pay an even bigger price, those who jump on during a plunge need to define their risk as well and especially not be willing to be punished by it.

The right way to play a bottom play is to first seek to discover what has really changed to change the market’s outlook on a stock, and unless you are trading it and are willing to just go with the trend, staying on while it is going your way and jumping off once it stops doing this, investors who plan on holding stocks for longer need to have enough going for them to make sense of this.

While Chesapeake Energy took a much bigger hit from the coronavirus sell-off than your average stock, the idea behind the good rebound plays was the temporary nature of the impact of all this, where we saw stocks take too big of a hit relative to their longer-term outlook.

When your longer-term outlook is as bad as Chesapeake Energy’s is, you may have been put out of your house for a while but you need to have a house to come back to when it’s over, not one that has been burned to the ground. There’s just nothing to come back to for Chesapeake Energy other than a house of horrors where more and more pain seems inevitable.

We have seen energy prices come back by a good amount, but not to a level that Chesapeake Energy can do anything but add significantly to their losses. With the cupboards so bare now, down to the crumbs, and with the dreams of this company coming to such an ignominious end, dreams that were far too big and ended up coming back to haunt them so much, and with the vultures now swarming overhead, this is indeed not a stock to mess around with now, a strong sell if there ever was one.

Ken Stephens

Chief Editor,

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.