Should Value Investors Take Another Look at Chesapeake Energy?

If you're reading this, then it is likely you're interested in sifting through the carnage that has plagued the oil sector over the past year. After all, it's not every day that an industry that is crucial to our modern society experiences a major cyclical pullback. There's no shortage of oil companies that have seen their shares sold off to multi-year lows but one in particular, Chesapeake Energy (CHKA.Q) has been particularly hard hit. Despite the fact that it is the second largest natural gas producer and 11^th largest crude oil producer in the U.S., its shares have plunged 70% since last summer. Which of course begs the question, is it time for value investors to take a closer look at this beleaguered energy company?

Chesapeake's Case
While Chesapeake has continued to broadcast increased efficiencies in energy conference presentations and investor conference calls, management's opinion of the intrinsic value of the company's shares remains sparse. The reason for this is simple, Chesapeake has not been cash flow positive for years and relied on production growth funded with debt for much of its GAAP earnings. This has had predictable consequences.

This does not mean that Chesapeake's shares are without merit, though. It should be noted that Chesapeake's management seems to be fully aware of its issues. Since the 2013 departure of the company's founder, Audrey McClendon; the company has focused on profits, cut costs, and continued to shed non-core assets. Chesapeake has been extremely successful in these initiatives: the sale of its Southern Marcellus and Utica Shale assets generated over $5.37 Billion in proceeds in October 2014. It is now a leaner, more focused operator. What this means for investors is that CHK can now focus on developing it prime reserves, which includes acreage in the coveted Eagle Ford shale region of southern Texas, where Chesapeake has 19% of its proved reserves.

Despite its recent travails, Chesapeake is turning the ship around and in order to properly value the company we simply need to dig a little deeper.

Past and present
In evaluating Chesapeake, we need to keep in mind that a great deal of the company's future success depends on the prices of its base commodities: crude oil and natural gas. Since we don't have a crystal ball, this is tricky. Nevertheless, comparing Chesapeake's most recent results with those of its peers (companies with similar production mixes and diversification), Devon Energy, and Anadarko Petroleum (APC)

Source: S&P Capital IQ

Anyone who has a bit of accounting experience that has been paying attention to the E&P space over the last 12 months is no doubt aware that things like GAAP earnings have been a little whacky for the group. Asset write downs, project sales, losses from operations due to low commodity prices, have all been the name of the game. All four of these names appear to offer compelling values on a P/E and Price/Tangible book value basis, with Chesapeake sticking out from the pack on both counts. However, to really get a feel for how these companies are functioning in the current environment, a little margin analysis is in order:

Source: S&P Capital IQ

Anadarko clearly sticks out from the pack thanks to its strong margins, which are aided by Anadarko's global presence. However, even diversification hasn't saved Anadarko from the industry wide carnage, as evidenced by multi-billion dollar asset write downs in recent quarters which have taken their toll on its net income margins.

It's clear that Chesapeake is the weaker operator of the three, but remember it is just now in the process of cutting costs and focusing its efforts. This process begun in 2013 is being hampered somewhat by the current oil price crash but it seems probable that Chesapeake will emerge on the other side a stronger company. Chesapeake is not only trading at a steeper discount to its tangible book value and its past earnings relative to its peers, but it is doing so while maintaining decent margins (albeit not great ones). That's all well and good but to really answer the question of whether or not CHK is cheap enough for value investors we need a historical perspective:

Source: S&P Capital IQ

This chart says it all. Chesapeake not only trades at a discount to its peers, but to its own average valuation over the last decade. If that isn't attractive to the value conscious investor I don't know what is.

The only possible hitch to all of this is that low energy prices actually cause companies like Chesapeake to drastically write down the value of assets on its balance sheet, while simultaneously bleeding it of liquidity. Fortunately the prognosis here is good as well. It's balance sheet may take some write downs, but CHK will still own some of the best acreage in the United States. Regarding liquidity: At the end of the first quarter, Chesapeake sported a total debt/capitalization ratio of 44.5%, which isn't terrible and stacks up with Devon at 33.7% and Anadarko at 49.1%. Chesapeake's liquidity is also looking reasonable: its current ratio last sat at exactly 1.0, its quick ratio at 0.9, both of which included a cash balance of over $2.3 billion. 

Foolish final thoughts
Exploration & production names like Chesapeake are trading at their lowest valuations since the Great Recession of 2009, as scores of investors throw in the towel on arguably sound enterprises. The weight of the evidence seems to point to Chesapeake being a classic bargain, and investors willing to step up to the plate and add it to a diversified portfolio of long term holdings will more than likely be rewarded.