Description

I recommend the purchase of Chesapeake Energy’s 6.625% senior notes due August 15, 2020 as a means to park cash for a year.  As CHK's earliest pending maturity and only $208 million outstanding, I believe the bonds are money good and, with a yield to maturity of 5.2%, the bonds compare favorably to one year CDs yielding 2.75% and short term bond funds and ETFs yielding 3.5% to 4.5%.

Chesapeake Energy.  CHK is an independent exploration and production company.  While historically, and still predominately, a natural gas producer, CHK is devoting most of its capital spending to growing its oil production - oil will constitute approximately 24% of CHK's 2019 production and generate over half its revenue.

Under the direction of its co-founder Aubrey McClendon, CHK went on a buying and drilling spree during the shale boom, leaving it with a lot of acreage, even more debt, a bloated cost structure, and a convoluted capital structure.  Current management took the reins in 2013 and has devoted its efforts since to winnowing assets, deleveraging, instilling cost discipline, and simplifying the capital structure.  These efforts have been largely successful, as CHK's expenses have been contained and its balance sheet greatly simplified.  Nonetheless, CHK remains overleveraged at over 3.5x EBITDA.

CHK currently operates in six geographic areas:  (1) the Eagle Ford Shale in South Texas, an oil and liquids play to which CHK is devoting approximately 24% of its cap-ex and which is generating significant free cash flow; (2) the Eagle Ford Shale and Austin Chalk formations in southeast Texas, an oil and liquids play which CHK acquired with its purchase of WildHorse Resource Development Corporation earlier this year, which is still in the development stage and to which CHK is devoting approximately 31% of its cap-ex; (3) the Powder River Basin in Wyoming, an oil and liquids play which is still in the development stage and to which CHK is devoting approximately 24% of its cap-ex; (4) the Anadarko Basin in northwestern Oklahoma, to which CHK is currently devoting minimal cap-ex; (5) the Marcellus Shale in Pennsylvania, a dry gas play to which CHK is devoting approximately 9% of its cap-ex and which is generating significant free cash flow; and (6) the Haynesville/Bossier Shales in northwestern Louisiana, a dry gas play to which CHK is devoting approximately 6% of its cap-ex and which is generating modest free cash flow.

6.625% Senior Notes.  $1.4 billion of Chesapeake Energy’s 6.625% senior notes due August 15, 2020 were issued in 2010.  The notes rank equally in right of payment with all of CHK's senior notes and are subordinate to CHK's revolving credit facility.  The notes are CHK's earliest pending maturity.  Through debt exchanges and debt repurchases, the outstanding principal was reduced to $437 million by December 31, 2018.  Pursuant to a debt exchange earlier this year, the outstanding principal was further reduced to a manageable $208 million.

Capital Structure.  CHK’s capital structure consists of a $3 billion credit facility ($1.22 billion drawn as of March 31, proforma for the repayment of 2019 note maturities paid in 2Q), $7.4 billion in senior unsecured notes, $1.67 billion (liquidation preference) of preferred stock, and common stock.  CHK's subsidiary, Bravos Valley Longhorn (formerly Wildhorse Resource Development) also has outstanding an available $1.3 billion credit facility ($688 million drawn at March 31) and $700 million in senior notes.  BVL debt is non-recourse to CHK.

Enterprise Value.  CHK’s enterprise value is as follows:

Debt.  CHK’s debt maturities are as follows:

Credit Facility.  The revolving credit facility has a borrowing base of $3 billion and matures in September 2023.  The credit facility requires CHK to maintain a leverage ratio of not more than 5.50 to 1 through the quarter ending September 30, 2019, decreasing over time to 4.50 to 1 for the quarter ending September 30, 2020 (and thereafter down to 4.0 to 1).  Without further asset sales devoted to debt repayment, CHK risks tripping this covenant in early 2021.  The facility also contains minimum fixed charge coverage requirements and maximum secured leverage ratios, neither of which are material to the current analysis.

Projected Cash Flows and Covenant Compliance.

The projections are based on the following assumptions:

• Realized prices are based on an approximation of the forward curve.  In that regard, (1) approximately 70% of CHK's remaining 2019 forecasted oil production is hedged at an average price of $58.75, and 80% of its remaining 2019 forecasted natural gas production is hedged at an average price of $2.83, and (2) approximately 20% of CHK's 2020 forecasted oil production is hedged at an average price of $58, and 33% of its 2020 forecasted natural gas production is hedged at an average price of $2.75.
• CHK achieves no further efficiencies in operating expenses in 2020 compared to 2019.
• CHK makes no asset sales through year end 2020.

For reference, consensus EBITDA estimates (per Reuters) are $2.752 billion for 2019 and $2,931 billion for 2020.

Cash Burn and Payment of Debt Maturities Through August 15, 2020.

There is sufficient cushion for the payment of the 6.625% notes at maturity in August 2020.  As additional comfort, there is substantial asset coverage for CHK's debt; the outstanding principal balance of consolidated debt is approximately 68% of YE 2018 PV-10 of $14.6 billion.

Risks.

• Risks associated with the WildHorse acquisition, including poor integration, poorer well performance than projected, higher operating costs than projected.
• Further sustained decline in energy prices.

Catalyst

Note Maturity