2023-06-28 13:49:05 ET
Summary
- Chesapeake Energy Corporation is well-positioned to benefit from the expected increase in natural gas prices.
- The company's disciplined capital program maximizes returns and generates sustainable free cash flow, supporting its peer-leading dividend and buyback program.
- I see a path towards a potential dividend hike coming in a couple of quarters from Chesapeake Energy.
Investment Thesis
Chesapeake Energy Corporation ( CHK ) is a natural gas producer. I argue that natural gas prices are heading higher and likely to stay at about $4 MMBtu in 2024. And given that context, considering Chesapeake now provides a compelling risk-reward situation.
For me, it's difficult for me not to get excited about natural gas prospects in the next twelve months.
That being said, rather than give you my views on natural gas demand drivers over the next 2 to 3 years, where I address the digitalization of the U.S. economy and its impact on driving up the need for more electricity, from air conditioners to EVs to AI data centers, instead I'll focus this time on describing the supply side of the equation.
Here, I explain why I believe that Chesapeake is cheaply valued and well-positioned to thrive in the next 12 months.
Why Get Bullish on Natural Gas? Why Now?
This graphic depicts the crucial drivers taking the natural gas supply away from the U.S. It shows that starting in 2024, there's going to be a +15% jump in natural gas exports relative to 2023.
15% increase in exporting capacity may not sound like much, but when the price of natural gas is very close to rock bottom prices, every change is accretive.
On the other hand, a 15% change in supply is clearly meaningful. Allow me to provide you with another example. If OPEC decided to cut oil production by 15%, what do you think would happen to oil prices? Right, oil prices would jump. And that's what's going to happen with natural gas, too.
In fact, I would argue that this is already taking place, see below:
As you can see, prices of natural gas in the month of June have already jumped more than 15%.
Of course, the price of natural gas is contingent on supply and demand. If supply remains high, then natural gas prices will remain low. And vice versa.
What you see above is that the U.S. Natural Gas rig count has tumbled since May. With a lower rig count, there's going to be less supply of natural gas, which will support higher natural gas prices.
With that context in mind, let's discuss Chesapeake's capital return program.
Capital Returns Program
The graphic above is slightly outdated, but it provides a rapid snapshot of Chesapeake's net debt position, including its hedging (more on hedging soon).
The takeaway here is that the Chesapeake carries minimal leverage, meaning that the bulk of the free cash flow Chesapeake makes can be returned to shareholders.
In fact, Chesapeake just paid out a quarterly base dividend plus a variable dividend of $1.18. I recognize that we shouldn't annualize this quarterly dividend to $4.72 and assume that the go-forward yield is 5.6%.
However, when we consider that in 2022 the total dividend payout reached $9.57 per share, I believe that thinking about a dividend in the ballpark of $4.70 makes a lot of sense.
On the other hand, I note that this dividend includes a variable component, which is not guaranteed.
Next, we'll turn our focus to Chesapeake's hedging.
Hedges in Focus
This is where one's take gets nuanced. Chesapeake typically hedges around the high 50s% of its production. I recognize that its 2024 production isn't hedged out yet, but there's still plenty of time for that.
And this hedging strategy plays both ways. If we were to assume that natural gas prices stay below $4 MMBtu in 2024, then Chesapeake is clearly in the winning seat.
But if we assume that natural gas prices are able to go beyond $5 MMBtu in 2024, in that case, Chesapeake won't fully benefit from the upside.
On yet the other hand, presently, it looks quite unlikely that natural gas prices in 2024 will go above $5 MMBtu and stay there.
In summary, I believe that paying about $11 billion market cap for Chesapeake is a compelling price, not only due to its very cheap valuation, of approximately 4x forward free cash flows. But also, given its likely +5% dividend yield.
Indeed, if we were to be bullish on natural gas, I suspect that given Chesapeake carries minimal debt, this would mean that it's well positioned to even further increase its dividend . Consequently, it's not entirely unlikely that Chesapeake might not raise its dividend payout further in the next few quarters.
The Bottom Line
Chesapeake Energy Corporation is positioned for success in the natural gas market.
The expected increase in natural gas exports by 15% in 2024 indicates a positive trend for prices, which have already seen a significant jump in June.
The decrease in the U.S. Natural Gas rig count suggests a reduction in supply, further supporting higher prices.
Chesapeake's minimal leverage allows for significant capital returns to shareholders, as demonstrated by its recent dividend payout.
While there is a hedging strategy in place, Chesapeake's cheap valuation and potential for a +5% dividend yield make it an attractive investment.
Finally, the company's ability to increase the dividend payout in the future adds to its appeal in the bullish natural gas market.
For further details see:
Chesapeake Energy: Thriving In Gas Market Surge