Chesapeake energy common is making its move – chesapeake energy corporation (nyse chk) seeking alpha electricity for refrigeration heating and air conditioning answer key


The buy and hold crowd tends to look at a longer time period. Those investors tend to hold even if the stock heads south. A trader may leave a stock on a 10% decline. But a long-term investor could hold with a 40% stock decline if analysis indicates that the original reason to invest is still intact. Fundamental analysis is far more important to the long-term buy and hold investor.

However, some knowledge of technical analysis is also required. Otherwise the long-term investor could find himself investing in front of a "technical analysis" train going full steam ahead. If that train is heading downward, it often helps long-term results immensely to wait for the train to stop. There is absolutely nothing wrong with allowing an irrational fundamental move due to technical analysis to play itself out before investing.

Similarly, while a trading investor pays far more attention to stock trading patterns than fundamental company analysis, a little fundamental analysis can sometimes avoid some dramatic chart changes. Even though Chesapeake Energy’s stock had a good week last week, it never hurts to review the long-term fundamentals. Then the investor can tell if this is a long-term trend or a part of the frothiness that is becoming more common with this aging bull market.

Net cash provided by operating activities finally jumped to some unacceptable level from abysmal as shown above. The cash shown above finally approaches the capital budget demands combined with the preferred stock dividend requirements. The last year or so it used the proceeds from some asset sales to help fund the budget and the preferred stock payments. Long-term debt payments were often offset by increases in the bank line or an increase in the negative working capital.

More importantly, the $9.4 billion long-term debt balance in the latest press release was unfortunately bolstered by a $300 million increase in the working capital deficit over the first quarter to more than $1 billion. That working capital deficit is a sign of a very unhealthy company. Management has the open bank lines necessary to pay bills. However, a negative working capital can be a sign of management working very hard to make sure that the long-term debt and bank line are kept as low as possible. Management is doing something allowed, but at the same time, something that may signal financial distress.

Furthermore, part of the cash flow from operations shown above was due to changes in other working capital accounts. That favorable change of about $100 million may reverse itself in the future. The rest of the increase was largely due to the lack of one-time payments.

Much of the Chesapeake Energy production is natural gas. Therefore, the lack of participation in the energy price rally is understandable. Even as oil prices have risen, gas pricing has remained weak much of the winter. The bright price future Mr. Market envisions for oil was just not the same for natural gas.

As shown above, oil production did increase. Oil is far more valuable than the cash produced. But Chesapeake is a large company. Management realizes that oil production needs to increase far faster than the first quarter comparison shown above if the company is to dig itself out of the debt stranglehold.

Announcements and presentations have emphasized the Powder River Basin as the future profit improvement center of the company. But the Eagle Ford needs to rapidly increase production also. Unless that happens, the latest stock price rally will be followed by a trip back down. That is not a suitable conclusion for buy and hold investors.

Large companies with massive production often need years to show tangible improvement. This company has really not shown production growth in some time. Now management appears to be forecasting low single-digit growth for the future. But some decent double-digit oil production growth is sorely needed. Current pricing would allow those oil wells to build up cash flow.

The long-term debt combined with the working capital deficit total more than $10 billion. Sufficient cash flow for that amount of debt would be $5 billion because a reserve is needed in case commodity prices decline. As stated in previous articles, lenders look for cash flow to be at least one-third of debt at all times (see my articles on Approach Resources ( AREX), Baytex Energy ( BTE), and Denbury Resources ( DNR) for examples).

The original presentation appears to be gone now, so an older article is referenced for this slide. The key takeaway for Chesapeake Energy investors is that the cash flow needs to increase or debt needs to decrease. Otherwise the current rally will most likely lead to a trading opportunity only. The 4.0 shown above is an absolute minimum. Many, including me, use a 3.0 ratio as a minimum because we rarely (almost never) see low cost loans with ratios higher than that.

I have followed too many companies that were unable to achieve the guidelines shown above to allow any consideration of them for long-term investment. Long-term buy and hold investment does not work with highly financially leveraged companies with insufficient cash flows. Fellow author Raw Energy shows the returns of the latest group in his periodic "Bottom Of The Barrel" articles. Short periods of great group returns are inevitably followed by long-term downdrafts that prevail. Only a very few companies have made it out of the club without reorganizing.

Most investors hope for an outcome like California Resources ( CRC) over the last year. The problem is that even diversification in a group of highly leveraged California Resources type stocks does not usually help returns. The risk of failure and the corresponding total loss of investment is simply too high. Instead, the agility to get out once the ride is over or the investor becomes uncomfortable is paramount.

Several have mentioned to me that they "guaranteed" a profit by cashing in enough stock to at least double their money before letting the profits ride. That is one consideration. The other consideration is keeping these type of stocks to a level commensurate with your ability to be able to watch them closely enough to ensure reasonable profits in good years and bad years. I generally have a mailbox full of investors who inevitably hold to the unpleasant end. These investors did not get out in time. Instead, they were mesmerized by the initial gains and held on through the losses hoping the stock would recoup the losses and go higher. I tend to write for the crowd that hangs on through thick and thin.

For that crowd, the current rally in Chesapeake Energy is a watch from the sidelines rally. The financial strength of the company is really too weak to justify the rally. There are many companies with low debt that will provide as good or better long-term returns. Investors can go to work, enjoy the family, and not be tied to the ticker tape.

Disclaimer : I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.