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This week we take a look at Chesapeake Energy(NYSE: CHK) starting today with an analysis of the company's fundamentals. Our analysis later this week will cover our assessment of its likely Corporate Actions, Dividend Quality, and Earnings Quality.

For details on how CapitalCube computes the Fundamental Analysis Score of a company read here. Our analysis is peer-based; we used the following peer set for analyzing Chesapeake: Anadarko Petroleum Corp.(APC), EOG Resources Inc.(EOG), Apache Corp.(APA), Devon Energy Corp.(DVN), Williams Companies Inc(WMB), Noble Energy Inc.(NBL), Hess Corp.(HES) and EQT Corp.(EQT).

If you are then you can change the default peer set (shown on the right) by either adding a new peer in the circled box or deleting any peers you don't want by simply removing the checked peers. When you re-run the analysis Chesapeake will be scored and analyzed with your new custom peer set.

Fundamental Analysis

 

• Chesapeake Energy Corp. trades at a lower Price/Book multiple (0.9) than its peer median (1.8).

• CHK-US looks challenged given its below median EBITDA-based returns and the market's low expectations of its growth.

• CHK-US has relatively low profit margins and median asset efficiency.

• Compared with its chosen peers, the company's annual revenues and earnings change at a slower rate, implying a lack of strategic focus and/or lack of execution success.

• CHK-US's return on assets currently and over the past five years has trailed the peer median and suggests the company might be operationally challenged relative to its peers.

• The company's relatively low gross and pre-tax margins suggest a non-differentiated product portfolio and not much control on operating costs relative to peers.

• While CHK-US's revenue growth in recent years has been above the peer median, the stock's Price/EBITDA ratio is less than the peer median suggesting that the company's earnings may be peaking and the market expects a decline in its growth expectations.

• The company's relatively low level of capital investment and below peer median returns on capital suggest that the company is in maintenance mode.

• CHK-US's operating performance may not allow it to raise additional debt.

Drivers of Valuation: Operations or Expectations?

Valuation (P/B) = Operating Advantage (ROE) * Growth Expectations (P/E)

Price/Book or P/B valuation is a function of the observed operating performance of the company as measured by ROE multiplied by the market's current implied growth expectation as measured by the P/E. We define Valuation Premium as the difference between the Market Capitalization and Book Value of Equity, and as a proxy for the NPV of cash-flow associated to the Book Equity investment.

Based on the analysis of the relative contribution to the P/B valuation of "Operations ROE" vs. "Expectations P/E", we quickly garner insight into peers comparative performance and the market's assessment of their strategies - are they just "Harvesting" the current business pipeline or are investors betting on a strategic "Turnaround"?

CHK-US has a challenged profile relative to peers.

CHK-US's PE multiple is negative now so EBITDA ratios provide better peer comparisons. CHK-US's performance looks relatively challenged because of its below median returns (EBITDA return on equity of 22.8% compared to the peer median of 33.5%) and the market's relatively low expectations of its growth (Price to Ebitda multiple of 3.7 compared to peer median of 5.3). The company trades at a lower Price/Book multiple of 0.9 compared to its peer median of 1.8.

Operations Diagnostic

CHK-US has relatively low profit margins and median asset efficiency.

The company's profit margins are below peer median (currently -5.7% vs. peer median of 9.9%) while its asset efficiency is about median (asset turns of 0.2x compared to peer median of 0.2x).

CHK-US has moved to a relatively low net margin from a relatively high net margin profile at the recent year-end.

CHK-US's net margin continues to trend downward and is below (but within one standard deviation of) its five-year average net margin of -2.8%. The decrease in its net margin to -5.7% from 16.6% (in 2011) was also accompanied by a decrease in its peer median during this period to 9.9% from 12.4%. Net margin fell 19.7 percentage points relative to peers (and is now also lower than its peer median).

CHK-US's asset turnover is downward trending and is now similar to its five-year average asset turnover of 0.3. Though its asset turnover has remained relatively stable at 0.2 compared to 2011, its peer median has decreased to 0.2 from 0.3 during this period. Overall, asset turnover and net margin trends suggest that CHK-US's ROA at -1.4% has maintained its downward trend and is below (but within one standard deviation of) its five-year average ROA of -0.1%.

Earnings Leverage

Lagging revenues and earnings imply a lack of strategic focus and/or ability to execute.

Changes in the company's annual top line and earnings (12.0% and -1.8% respectively) generally lag its peers. This implies a lack of strategic focus and/or inability to execute. We view such companies as laggards relative to peers.

Sustainability of Returns

CHK-US's relative returns suggest that the company has operating challenges.

CHK-US's return on assets is less than its peer median currently (-1.4% vs. peer median 2.6%). It has also had less than peer median returns on assets over the past five years (-0.06% vs. peer median 3.5%). This performance suggests that the company has persistent operating challenges relative to peers.

Drivers of Margin

Relatively low margins suggest a non-differentiated product portfolio and not much control on operating costs.

The company's comparatively low gross margin of 36.9% versus peer median of 66.0% suggests that it has a non-differentiated strategy or is in a pricing constrained position. In addition, CHK-US's bottom-line operating performance is below peer median (pre-tax margins of -7.6% compared to peer median 16.6%) suggesting relatively high operating costs.

CHK-US has moved to a Commodity/High Cost from a Commodity/Low Cost profile at the recent year-end.

CHK-US's gross margin is its lowest relative to the last five years and compares to a high of 61.2% in 2007. The decrease in its gross margin to 36.9% from 38.6% (in 2011) was also accompanied by a decrease in its peer median during this period to 66.0% from 73.9%. Gross margin rose 6.2 percentage points relative to peers.

CHK-US's pre-tax margin is downward trending and is below (but within one standard deviation of) its five-year average pre-tax margin of -4.2%. Like the gross margin trend, the decrease in its pre-tax margin (to -7.6% from 26.0%) was also accompanied by a decrease in its peer median during this period (to 16.6% from 19.3%). Relative to peers, pre-tax margin fell 30.9 percentage points (and is now also lower than its peer median).

Growth Expectations

The company's earnings may be peaking.

While CHK-US's revenues growth has been above the peer median (-1.1% vs. -1.6% respectively for the past three years), the stock's Price/EBITDA ratio of 3.7 is less than the peer median (Note: We use Price/EBITDA instead of PE due to negative earnings). This implies that the company's earnings are peaking and the market expects a decline in its growth expectations.

Capital Investment Strategy

CHK-US seems to be in maintenance mode.

CHK-US's annualized rate of change in capital of -3.5% over the past three years is less than its peer median of 10.9%. This below median investment level has also generated a less than peer median return on capital of -2.7% averaged over the same three years. This outcome suggests that the company has invested capital relatively poorly and now may be in maintenance mode.

Leverage & Liquidity

CHK-US would seem to have a hard time raising additional debt.

With debt at 27.5% of its enterprise value compared to an overall benchmark of 25% (Note: The peer median is currently 17.7%), and relatively tight interest coverage level of 0.5x, CHK-US would have a hard time raising much additional debt. All 9 peers for the company have an outstanding debt balance.

CHK-US has maintained its relatively low liquidity profile from the recent year-end.

CHK-US's interest coverage is its lowest relative to the last five years and compares to a high of 141.5x in 2010. The decrease in its interest coverage to 0.5x from 1.8x (in 2011) was also accompanied by a decrease in its peer median during this period to 3.4x from 5.5x. Interest coverage rose 0.8 points relative to peers. It is also below the 2.5x coverage benchmark unlike the peer median.

CHK-US's debt-EV has increased 6.8 percentage points from last year's low and is now above its five-year average debt-EV of 25.0. While its debt-EV increased to 27.5% from 20.7% (in 2011), its peer median decreased during this period to 17.7% from 18.4%. Relative to peers, debt-EV rose 7.5 percentage points. Unlike the peer median, it is also above the 25% leverage benchmark.

 

For Key Valuation Items, Revenues & Margins, Key Assets (% of Revenues), Key Working Capital Items, Cash Management Indicators, Key Liquidity Items, Key Cash Flow Items (% of Revenues) please log-in.

Company Profile

Chesapeake Energy Corp. (NYSE: CHK) explores, develops and produces oil and natural gas properties. Its principal activities include discovering and developing unconventional natural gas and oil fields onshore in the U.S. The company has also vertically integrated its operations and owns substantial marketing, midstream and oilfield services businesses directly and indirectly through its subsidiaries Chesapeake Energy Marketing, Inc., Chesapeake Midstream Development LP, Chesapeake Oilfield Services LLC, and Chesapeake Midstream Partners LP. Chesapeake Energy operates its business though the following segments: Exploration and Production; Natural Gas and Oil Marketing; Gathering and Compression; and Oilfield Services. The Exploration and Production segment is responsible for finding and producing natural gas and oil. The Marketing, Gathering and Compression segment is responsible for marketing, gathering and compression of natural gas and oil primarily from Chesapeake-operated wells. The Oilfield Services segment is responsible for contract drilling, oilfield trucking, oilfield rental, pressure pumping and other oilfield services operations for both Chesapeake-operated wells and wells operated by third parties. The company was founded by Aubrey K. McClendon and Tom L. Ward on May 18, 1989 and is headquartered in Oklahoma City, OK.

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