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Chesapeake Energy is Fairholme Capital’s new position

Santiago Solari - Author
By

Aug. 18 2020, Updated 5:18 a.m. ET

Fairholme Capital’s 3Q14 positions

In 3Q14, Fairholme Capital Management added a new position in Chesapeake Energy Corporation (CHK) and increased its stake in Sears Holdings Corporation (SHLD). The fund also sold its common equity positions in government-sponsored enterprises Fannie Mae (FNMA) and Freddie Mac (FMCC). It exited its stake in Genworth Financial (GNW) and reduced its positions in American International Group (AIG), St. Joe Company (JOE), Lands’ End (LE), and Leucadia National Corporation (LUK).

Fairholme purchased ~537,000 shares of Chesapeake Energy Corporation (CHK) for $12.3 million in 3Q14. It now accounts for 0.16% of the portfolio.

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In our October coverage of Fairholme’s 2Q14 portfolio, we discussed why the fund sold its entire stake in Chesapeake Energy (CHK) following a slip in earnings. However, in 3Q14, Fairholme decided to regain its original exposure to Chesapeake Energy (CHK), which now accounts for 0.16% of the total assets under management. The rationale behind this move was Chesapeake Energy’s successful asset divestment of its shale reserves, which significantly reduced the company’s leverage, improved its liquidity profile, and lowered its operating cost structure.

Overview of Chesapeake Energy

Chesapeake Energy Corporation (CHK) is an eminent energy exploration and production company in the United States. Its operations span the Marcellus, Utica, Niobrara, Mississippian Lime, Eagle Ford, Barnett, and Haynesville shales. It’s currently the second largest producer of natural gas and the eleventh largest producer of liquids in the United States.

The company produces more than 720,000 barrels of oil equivalent per day and operates both in the upstream and downstream spaces. Its operations can be broadly categorized into the following two segments­­:

  1.  Exploration and Production, which accounts for nearly 40% of 3Q14 revenues
  2. Marketing, Gathering, and Compression, which represents the remaining 60%
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Asset divestment

In October 2014, Chesapeake Energy (CHK) sold a portion of its assets in the Southern Marcellus Shale and certain assets in the eastern Utica Shale to Southwestern Energy for $5.4 billion. The divestment of its Marcellus assets was due to infrastructure limitations, and the Utica reserves were sold in order to reach its broader goal of tilting its portfolio toward the high margin crude production. Although its production continues to center on natural gas production (~71% of total production in 3Q14), the divestment greatly benefited the company in terms of strengthening its balance sheet and lowering its cost structure.

The divestment was well accepted by the market. Its stock prices went up by ~17% to $19.55 on the day of the announcement.

3Q14 performance and FY14 outlook

Chesapeake Energy’s (CHK) 3Q14 results reinforced investor confidence as the company experienced revenue growth of 16.3% year-over-year to $5.7 billion. This, coupled with unrealized gains on derivative hedges and lower operating cost, resulted in a net income of $169 million compared to $156 million in 3Q13. Its revenues of $5.7 billion and adjusted earnings per share (or EPS) of $0.38 in 3Q14 beat Wall Street estimates of $4.8 billion in revenue and $0.33 in adjusted EPS. The company was able to achieve these results largely due to an uptick in its production, which averaged 726,000 barrels of oil equivalent (or mboe) per day in 3Q14, representing a 11% increase from the prior quarter when adjusted for asset sales.

Management expects its liquids production to witness continued growth of 29% to 33% by year end. It believes the company is now well on track to reach its target daily equivalent production of 730 mboe by the year end.

From a valuation standpoint, Chesapeake Energy (CHK) seems slightly undervalued at the moment with a forward price/earnings ratio (or P/E) of 12.1x compared to a peer average of 13.3x.

Investors seeking to gain exposure to Chesapeake Energy (CHK) and other natural gas producers such as Cabot Oil & Gas Corporation (COG) and EQT Corporation (EQT) can consider ETF vehicles such as the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) and the Energy Select Sector SPDR ETF (XLE).

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