Pay Close Attention to Chesapeake Energy Corporation (CHK)

Chesapeake Energy Corporation (NYSE:CHK), despite its heavy debts, has an edge over its rivals. It’s regarded as a highly efficient gas operator. The industry’s average cost to find and develop a gas well stands at roughly $3 per mcf. Chesapeake spends only $2.20 per mcf, while SandRidge Energy Inc. (NYSE:SD) and Plains Exploration & Production Company (NYSE:PXP) each pay roughly $3.30 per mcf.

In contrast to the trio, EXCO Resources Inc (NYSE:XCO), the company that just acquired the Eagle Ford assets from Chesapeake Energy Corporation (NYSE:CHK), is in a different financial situation. It has $1.8 in total equity value and $1.3 billion of net debt, of which only $192 million is classified as current liabilities. This allows the company to be much more flexible with its financials than the other three.

Valuation

Cash flow is the most important gauge in valuation of gas and oil companies because maintaining low overhead expenses is absolutely crucial. EXCO brought in $514 million of cash from operations in 2012. That’s up from $428 million and $340 million in 2011 and 2010, respectively. This commands a price-to-cash multiple of 3.6 times. That’s very cheap, but it also represents fear in the market that EXCO Resources Inc (NYSE:XCO) will outspend itself. With a negative operating margin of 6%, these fears might actually be justified. In contrast to EXCO, SandRidge has brought in only $120 million in cash flow, down from $198 million only a year ago. This commands a high price-to-cash multiple of 20 times. In SandRidge’s case, the bottom line is very important. While its operating margin is 30%, its bottom-line net profit margin is a negative 4%.

A recent vote of confidence

The Fool looks ahead

I believe that Chesapeake has been making good progress in the right direction. With the disposal of assets in return for immediate cash, Chesapeake is currently paving its way out of what seemed like potential insolvency. Once everything is clear and the dust settles, the company’s depressed equity could receive a great boost from these moves. Invest accordingly.

Shmulik Karpf has no position in any stocks mentioned. The Motley Fool has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. Shmulik is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

The article Pay Close Attention to Chesapeake Energy originally appeared on Fool.com is written by Shmulik Karpf.

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