A funding gap: Chesapeake Energy’s $1 billion cash flow deficit
Operating cash flow of $5.2 billion versus capex and capitalized interest of $6.2 billion
Based on Chesapeake’s production forecasts, and assumptions of a NYMEX Henry Hub natural gas price of $4.00 per thousand cubic feet (current prices are at ~$4.80, with the 12-month strip at ~$4.60) and $90 per barrel for NYMEX WTI crude oil (current prices are at ~$100, with the 12-month strip at ~$95), the company estimates operating cash flow of $5.1 billion to $5.3 billion. With operating cash flow of ~$5.2 billion, and a capex budget of $5.4 billion, it appears that CHK would only outspend cash flow by ~$200 million.
However, note that CHK capitalizes most of its interest. What this means is that the interest expense on most of its debt doesn’t appear on the interest expense line of its income statement, but rather is lumped in with its capital expenditures on its cash flow statement. Where the interest gets lumped in doesn’t matter from a practical standpoint, because CHK still has to make the same interest payments. Taking into account estimated interest expense of ~$800 million over 2014, CHK will be outspending cash flow during the year by ~$1 billion. Management noted on the call regarding this guidance that part of the funding gap will be filled with CHK’s sale of its interest in Chaparral Energy (another oil and gas company) for $215 million. The announcement of this sale was made several weeks prior.
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Note: This graphic is sourced from Chesapeake’s company presentation and does not include the effect of capitalized interest, estimated to be ~$800 million in 2014.
Funding gap likely to be filled with asset sales, but it’s not clear which assets yet
Essentially, what this means is that CHK will be generating ~$5.2 billion of cash through the year, but would be spending ~$6.2 billion—including capitalized interest. Management affirmed, “We continue to make progress evaluating non-core asset sales as we will be divesting additional properties in 2014. Our 2014 capital program and production growth profile is not dependent on any asset sales.”
However, when pressed on the call to explain the particulars of potential divestitures, CHK’s chief financial officer, Domenic Dell’Osso, commented that he was not ready to discuss what sorts of asset sales it might close through the year, though the company was constantly evaluating the “strategic merits” of assets currently in its portfolio. The CFO also mentioned that the company planned to reduce debt this year and implied that the company wouldn’t issue additional equity. Asset sales are one of the main available options to both fill the company’s gap and reduce its debt without issuing equity, so it’s very possible that CHK will announce further asset sales in 2014.
Chesapeake has stated that as part of its long-term strategy, it would like to balance its capex spending with cash flow from operations, divest non-core assets, and achieve investment-grade metrics (which would imply debt reduction, or delevering through growing cash flow).
The funding gap is large, but still more reasonable than past years
While Chesapeake will be outspending cash flow by roughly $1 billion this year, this still represents a significant improvement from prior years when the company outspent cash flow by several billion dollars per year. To give some context, CHK’s former management, including CEO Aubrey McClendon, had followed a consistent pattern of spending billions on leasehold capex (money spent to acquire leases on which to drill). Historic spending was such that it chronically outstripped the company’s operating cash flow, and the gap would be filled with selling or joint venturing assets to get cash in the door. In 2013, new management took over with a message of financial discipline and a promise to get the balance sheet in shape. So while 2014 represents an improvement in free cash flow over past years, the market was probably largely expecting this from CHK’s new management team.