The hardest thing for value investors oftentimes is to stand by one’s convictions, even when Wall Street doesn’t seem to take notice of what you see. Shares of natural gas producer Chesapeake Energy (CHK) have been doing nothing for more than a year. Many investors have likely grown tired from Wall Street’s yawns and have moved on to more hip names. However, CHK’s fourth quarter earnings report issued yesterday afternoon once again shows that the company is clicking on all cylinders.
Chesapeake reported earnings of $0.90, 13 cents above estimates of $0.77 per share. Revenue came in at $1.87 billion, versus the consensus view of $1.52 billion. Spectacular quarters are nothing new for CHK, as they have reported stellar results for many quarters in a row now. However, the stock has merely been tracking the commodity price of natural gas, ignoring the fact that shares trade at 8 times trailing earnings and 5 times trailing EBITDA.
The weakness in Chesapeake shares, relative to its operating results, is likely due to two things. First, CHK has issued a lot of convertible debt to fund increased natural gas production, and continues to do so. In order to hedge their positions, buyers of the convertible debt simultaneously short the common stock in order to lock in the income generated from the convertible securities. The good news is that the land grab that CHK has embarked on is largely over so they are doing fewer acquisitions. In fact, CHK’s long term debt actually fell in Q4 for the first time in a long, long time.
Investors also worry about falling natural gas prices when analyzing Chesapeake shares. This explains why CHK has been following spot gas prices for months now. This logic, though, ignores CHK’s massive hedging activities (they sport the most aggressive hedging program in the industry). The company has hedged 50% of their gas production above the current market price for both 2007 and 2008. As a result, commodity price risk should not be a large concern for CHK investors.
As value investors know, it often takes a long time for Wall Street to realize that they have mispriced equities. Over the long term, CHK stock has reflected the value of its underlying business, even when short term movements do not. This time should be no different. And if the company’s management team grows tired of waiting for their value to be realized, they surely would have numerous options if they were to sell their company outright to get out of the fickle public marketplace.
Full Disclosure: Long CHK common stock, as well as the preferred “D” shares