Chesapeake Energy is worth a look

Profits are strong despite weaker natural gas prices. LNG is a tailwind

Chesapeake (CHK) had decent second quarter with net income and cash flow running at expected rates or better. With production of 3.7 Bcf per day, Chesapeake is a major player in the natural gas space, larger than Canadian giant Tourmaline (TOU.TO) and with a similarly low cost structure.

With CHK stock trading in the US$87 range, the market is valuing the company at single digit multiples of net income and cash flow. Chesapeake has a clean balance sheet with net debt of about US$1 billion, a fraction of its annual cash flow. Dividends (trailing twelve month) comprise both base and extra dividends for a yield close to 10% and the company has been buying back shares as well.

It is hard to get too excited about natural gas with prices down sharply from last year and the prospect of a warm winter with El Nino in evidence. It is easy to get excited about natural gas stocks in such an environment, since they trade at depressed prices. Longer term, natural gas is fundamental to world energy supply-demand balances and Europe and Asia are short of gas, creating a growing LNG market. The LNG opportunity is the one our Prime Minister, Justin Trudeau, dismissed out of hand saying there was “no business case” for LNG. Like most climate nutters, Trudeau has no clue about business economics or the importance of building a robust fossil fuel industry. But the LNG opportunity is substantial.

Chesapeake projects U.S. LNG exports will reach almost 27 Bcf/day by 2027. For reference, total U.S. natural gas production runs about 100 Bcf/day and total Canadian output is about 17 Bcf/day, with combined U.S. and Canadian domestic demand averaging about 90 Bcf/day. While that may appear to be in balance, natural gas is exported to Mexico and the Biden Administration has committed to LNG shipments to Europe while Asia is a major importer of LNG. The near collapse of the United Kingdom economy last winter reflected nosebleed energy prices and a severe shortage of natural gas worsened by issues related to the Ukraine war, sanctions and damage to a major pipeline from Russia which some believe was carried out by the U.S. Geopolitics are a factor in energy security regardless of what one believes about the pipeline explosion.

When you can buy top flight natural gas producers with yields approaching double digits when natural gas prices are in the basement and enough cash flow to support those yields without added debt, you are on the right side of the street for the next up-cycle in natural gas demand and prices. It may be a year or two before El Nino passes and we experience another bitter cold winter, but history has taught us that when that happens natural gas prices rise sharply and tend to remain high for some time. It was not that long ago that gas was $10 per gigajoule compares to the current price one quarter of that.

Futures markets suggest natural gas prices will rise this fall despite the projected warm winter. At the Nymex December contract price of US$3.50 per million BTU, Chesapeake makes a lot of money on its 3.7 Bcf/day of output.

I own Peyto (PEY.TO) and Birchcliff (BIR.TO) and have dabbled in Tourmaline (TOU.TO) and Chesapeake (CHK) profitably but have now decided to increase my exposure to the U.S. gas industry and add more Chesapeake stock. It is (in my opinion) too cheap to ignore and the rumors of the death of fossil fuels are greatly exaggerated.