bellard (99.45)

Ride the waves of change - Chesapeake Energy

March 19, 2008 – Comments (3)

A tidal wave is coming to the US, and Chesapeake Energy will be surfing like a pro! This change I am talking about is the use of natural gas in the US. Many economic experts agree that pollution taxes, or a cap and trade pollution system will become reality in the next few years. I have written in February about my vision of the future of natural gas.

For me to invest in an equity, I like to see two things. The firm is in an industry with positive future dynamics, and the discounted cash flow value of the firm is much higher than the current stock price.

Chesapeake  has both of these points covered. Chesapeake reported another stellar quarter last month, with adjusted EPS from continuing operation of .93, and cash flow of 1.3 billion. EPS was only up 3% from 2006, but the NG prices were 8% higher in 2006. Other highlights from the quarter:

Production increases of 23% year-over-year

Proved reserves increase of 21% year-over-year

Preferred stock redemptions saving 55 million per year.

Reserve replacement rate of 369% 

For 2007, Chesapeake's  adjusted  EPS was 3.21.  EPS was down about 11%, but again the natural gas prices were 7% higher in 2006. Cash flow from operations was 4.6 billion, up 15% from 2006.

These adjusted EPS numbers are net of one time charges and Chesapeake's unrealized gains/losses from its hedging program. Chesapeake's GAAP numbers can be complex, but cash flow is not. This is reason # 15 I focus on cash flow analysis, and not GAAP accounting numbers.

The Chesapeake conference call was also positive. Chesapeake stated that it will stay with its plan of managed growth. For 2008, Chesapeake expects the range for natural gas prices to be in the range of 8-10, verses the old range of 6-8. For every .10 cents increase in NG prices, Chesapeake's reserves increase by 400 million.

Looking at longer term growth rates, here are the impressive 3 and 5 year averages:

        
                                      3 yr               5yr

________________________________________________ 

Revenue                         42%               60%

EPS                              20%                70%

Net asset value               60%                65%

Cash flow from Op's        55%                67%

Chesapeake current cash flow yield is over 20%. With higher 2008 natural gas prices, and Chesapeake reserve replacement rate over 350%, the stock looks very strong. With clean natural gas becoming a larger part of our electric generation, Chesapeake's cash flows should grow 20% per year over the next 5 years. My current DCF valuation for CHK is now around 70.