Chesapeake Energy (CHK) is the nation’s largest independent producer of natural gas. It has a stake in just about every noteworthy natural gas play in the United States. Moreover, Chesapeake has led the charge when it comes to tapping into our country’s shale plays. It owns the rights to drill on prime unconventional properties like the Marcellus, Haynesville, Barnett, Granite Wash, and Eagle Ford shales. Indeed, the company has been very successful in identifying prime shale assets. This has enabled them to acquire the leasehold drilling rights early on, before competitors have come in and driven up prices. 

At the same time, Chesapeake has perfected the art of horizontal drilling, the process needed to extract the hydrocarbons from these somewhat difficult locations.  Chesapeake’s innovation has resulted in the nation’s most active drilling program, with a success rate of 99% for company-operated wells and 98% for wells operated by others.  At the end of the September period, the company’s proved natural gas and oil reserves advanced to roughly 16.2 trillion cubic feet. 

Meanwhile, Chesapeake has been utilizing asset sales in an effort to free up cash. These deals, known as volumetric production payments (VPPs), have generated cash of about $4.7 billion, thus far.  Due to the company’s pioneer mentality with respect to the shale plays, it has been able to get great deals on leasehold pricing. After Chesapeake starts to produce solid results at the wellhead, other companies want to get involved. And, Chesapeake is more than happy to oblige, for a price. These deals include the sale of a portion of the leasehold asset, along with a set amount of proved reserves and current net production per day, but not the entire asset, allowing Chesapeake to maintain an often material stake in the property. Profits on the VPPs have been robust enough to cover Chesapeake’s initial investment, and often result in the company getting its remaining stake essentially free. Currently, it has multiple opportunities for similar deals in its pipeline.

More recently, Carl Icahn announced that he has accumulated a 5.8% stake in the natural gas producer. After news broke that the billionaire activist investor had taken a shine to shares of CHK, the stock traded 15%-18% higher. This likely stemmed from Wall Street’s positive image of Icahn’s past deals. Often times, he is able to work with companies to unlock value, resulting in share price gains. In-house, CEO Aubrey McClendon has been in the process of monetizing the company’s assets for some time now, specifically with the aforementioned VPP deals. In fact, the company recently announced a new strategic and financial plan known as the “25/25 plan”. It will attempt to reduce Chesapeake’s debt by 25% over the next two years and trim the two-year production growth target by 25% as well, largely through assets sales.

However, the recent run-up in price, of approximately 31% since our December review, does erode a portion of the capital gains potential we are projecting through 2013-2015. That is not to say that CHK shares are no longer attractive. Indeed, they still offer slightly above-average appreciation potential for the coming 3 to 5 years, when compared to the Value Line median. That said, we think investors may benefit from patiently awaiting a more attractive entry point. 

From a technical standpoint, there is resistance at the $28 price range when viewing the recent daily chart, and at the $30 price range, which coincides with the stock’s 200-week moving average, on the weekly chart. Looking back to late 2009 and early 2010, Chesapeake tested this $28 price range three times before trending lower throughout most of 2010. And, at the same time, oil prices recently dipped below $90 a barrel, which will also likely apply some pressure to natural gas prices and, subsequently, natural gas related stocks. 

On balance, nothing goes up or down in a straight line.  And we think it is possible to get in at a more attractive stock price. We would not be surprised by a 10%-15% price correction in the near-term. That would put the stock back near its 50-day moving average and we believe that such a price point would represent an advantageous entry level.  Over the longer term, Chesapeake is the leader in its industry and we like its 3- to 5-year prospects. Mr. Icahn appears to be on the right track with his recent purchases of CHK at about $22-$23 a share. That said, once the glow of his “Midas touch” subsides and lower commodity prices work through to natural gas stocks, a correction in price will likely ensue, allowing patience to pay off for investors interested in these shares.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.