Professional traders often say that the first move is always wrong; how much traction that saying has over shares of Chesapeake Energy Co. (NASDAQ: CHK) is up for debate. After reporting its first quarter 2024 earnings, arguably the most critical earnings as they set the tone for the rest of the year, a decline in the stock price could be an opportunity in disguise.
As the company focused on natural gas over crude oil production, Chesapeake’s financials show signs of contraction for the short term. However, over the long term, management plans to deliver over triple-digit growth in earnings per share (EPS), which Wall Street analysts certified in their official projections.
Driven by a global macro trend, energy stocks could be setting up for a breakout soon. Warren Buffett saw it fit to boost his own position in Occidental Petroleum Co. (NYSE: OXY) in the past quarter. However, oil and natural gas (typically highly correlated and tied) have now diverged to give Chesapeake the push it needs.
What’s Driving The Sector?
[content-module:CompanyOverview|NASDAQ: CHK]For the first time since the COVID-19 pandemic, the U.S. economy is now driven by two diverging sectors. On the one hand, business services have been solely responsible for any positive rate of gross domestic product (GDP) growth this year.
On the other hand, the U.S. manufacturing sector has been declining for over a year and a half, only to read its first expansionary month in the latest ISM manufacturing PMI index. Far from being the final confirmation, some on Wall Street think that the rest of 2024 could be led by manufacturing rather than services.
At least that’s what analysts at The Goldman Sachs Group Inc. (NYSE: GS) think, as they expressed their views favoring a manufacturing breakout within the bank’s 2024 macro outlook report.
Because manufacturing activity means higher oil demand, Goldman said oil could reach $100 a barrel this year. Recently, oil prices broke away from their previous $80 ceiling, reaching $90 in April to take a breather, leaving room for another potential rally.
Natural gas prices, however, lagged behind during the past quarter. Natural gas futures fell by as much as 56% since January 2024, while the price per barrel rose by 18% during the same period.
The Energy Select Sector SPDR Fund (NYSEARCA: XLE) underperformed Chesapeake by 5% over the past quarter despite holding mostly oil names. Price action would suggest that markets believe natural gas’ catch up to crude may pose a more significant potential reward.
Chesapeake’s Deep Value: Wall Street’s Bet
Despite seeing a contraction across the board in the first quarter, Chesapeake’s financials still show a hidden treasure most may have missed. The company’s balance sheet would show a net increase in natural gas inventories and properties of 3.1%, bringing its total value to $11.8 billion.
More than that, according to Bloomberg Intelligence, Chesapeake is building up new gas wells in their latest round of capital expenditures. Up to 80 new natural gas wells are expected to be put into suspended animation by the end of 2024, to be turned on by the time natural gas catches up to oil.
Wall Street analysts see the company’s EPS growing 230.1% in the next 12 months, significantly above the oil industry’s 19.3% average growth rate. Compared to competitors like Murphy Oil Co. (NYSE: MUR), which is only expected to see 33.8% EPS growth, Chesapeake seems to be the right deal.
Analysts at Scotiabank saw enough evidence to boost their price targets for Chesapeake up to $110 a share, calling for a 22.5% upside from today’s prices. Despite being down by 6.5% in the after-market hours following the quarterly earnings announcement, Chesapeake’s future could still be sealed.
With up to 97.9% institutional ownership, Chesapeake’s investment-grade balance sheet, with no debt maturities for the next two years (according to management’s presentation), gives investors access to up to $3.7 billion of liquidity.
Another thing to look out for is Chesapeake’s attempted takeover of Southwestern Energy Co. (NYSE: SWN), which is yet another bet into the future of gas. Temporarily blocked by the Federal Trade Commission (FTC), a resolution would make Chesapeake the largest gas producer in the U.S.
Despite contracting financials as the company ramps up its natural gas exposure, the first quarter of 2024 still saw enough free cash flow (operating cash flow minus capital expenditures) to sustain Chesapeake’s 2.6% dividend today.
