Today’s Daily Alert introduces a new Top Pick for the second half of 2012 from Sound Advice. Editor Gray Cardiff’s original Top Pick, Transocean (RIG) was sold in the April 17 Daily Alert. (Click here to read the sell recommendation.)
“We sold Transocean (RIG) earlier this year. Our top pick is now Chesapeake Energy Corp. (CHK). Chesapeake Energy is an independent exploration and production company, dominant in the mid-continent region with expanding interests in the Appalachian Basin, the Barnett Shale, the Arkansas/Louisiana/Texas border area, as well as in south and west Texas, including the Permian Basin.
“Chesapeake’s production assets are almost entirely natural gas, which makes it a nearly pure natural gas investment. In fact, it is only second to Exxon as the country’s largest natural gas producer.
“Of course, due to the current state of the natural gas industry, CHK has been hammered, and is trading near the low end of its 52-week trading range. Given the depressed state of the natural gas industry, earnings estimates have been slashed to approximately $2.00 per share for 2012, although most analysts are projecting earnings to begin rising again in 2013, with an improving economy and strong growth in production from some of Chesapeake’s assets, especially from its Marcellus, Eagle Ford, and Anadarko Basin acreage.
“In 2011, CHK began a substantial shift from its emphases on natural gas to oil. Its Eagle Ford field is now producing approximately 45,000 barrels of oil per day and is ramping up its oil production so that it will likely account for close to one-third of its asset production over the next five years. In the event natural gas prices remain low, the increased oil production should substantially offset the stress from the natural gas sector. Based on the increased oil production, even with protracted low natural gas prices, Morningstar recently raised its fair value estimate for Chesapeake’s stock to $32 per share.
“However, it is hard to imagine how the outlook could be any more bleak for the natural gas industry, which means the news can only get better. We also note that futures prices for natural gas have been moving up during the last several weeks, which is indicative that the historically low prices of natural gas under $2.00 per million BTUs are just that — history.
“The stock is dirt cheap now, not so much because of its price relative to earnings, but rather because of the price in relation to its assets. While the long-term forces make this stock certain to be a real winner, the near term is impossible to predict and this stock may continue to be volatile over the near term.
“Recently, CHK suffered a jolt when the company filed its quarterly 10-Q report and a Wall Street Journal article reported that CHK has more liabilities than previously estimated by investors and analysts. The stock went to new low territory, dropping to a low-point of $13.32 a share on May 17. While not good news, when put into context of the overall $23.6 billion in liabilities, the $600 million increase is not a game-changer. It is widely known that historically low natural gas prices have put CHK into a crunch, and it is raising cash through asset sales in order to raise cash and lower its long-term debt.
“CHK recovered from its low point as rumors circulated that Carl Icahn recently bought a 7.6% stake, making him the third-largest shareholder. The rumors were verified. Icahn actually started buying on April 19 at higher stock prices. In keeping with his reputation as an activist investor who turns around companies, Icahn said he would demand the replacement of four board members at the June 8 annual stock-holders’ meeting — two for himself and two for Southeastern (the largest single investor), who already had Lou Simpson put on the board about a year ago. To avoid turmoil at the annual meeting, CHK is bowing to Icahn’s demands. Four board members resigned to make the room. Although Icahn and his constituents will not have a majority, the added attention is positive because the spotlight is on the board to do whatever it can to maximize shareholder value.
“We recommend buying under $20 per share.”
- Gray Cardiff, Sound Advice, June 2012