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Has Chesapeake Energy Really Done as Terribly as It Seems?

NEW YORK (TheStreet) -- Chesapeake Energy (CHK - Get Report) recently failed to meet market expectations on its earnings per share in its second-quarter earnings report. Analysts estimated the adjusted EPS to reach 44 cents a share, while the company's actual EPS was 36 cents a share -- 8 cents lower than market projections.

Does this mean the company didn't reach its quarterly goals in terms of production and costs?

Let's analyze the progress of Chesapeake in the past quarter and see if it actually did as poorly as it seems.

Despite the lower-than-anticipated EPS, Chesapeake Energy ended yesterday with a modest gain of 13 cents to $26.19 a share. And as of 1 p.m. Thursday, shares were down 1% to $25.94.

Must Read: Chevron, Exxon Highlight Up and Down Year in Oil Sector

Other oil and gas producers such as Chevron (CVX) also rallied yesterday and finished with a 0.62% increase to settle at $125.73 a share. Thursday Chevron sank to $125.41, off 0.25% as of 1 p.m.

During the second quarter, Chesapeake Energy reached its quarterly output goals as the total oil equivalent production was 63.2 million barrels of oil equivalent -- nearly 2.6% above the volume recorded in the second quarter last year. Most of the gain came from the rise in the company's natural gas liquids output, which grew by 62%, year over year.

Looking forward, Chesapeake Energy revised up its daily oil equivalent production to an average of 695,000 barrels of oil equivalent, a 1.5% gain from the previous estimate. This higher yield is likely to increase its sales in the coming quarters.

The company also improved its production costs in the past quarter, which had a positive impact on the profit margin. Alas, the main reason for the drop in earnings per share was the very low realized prices of oil and natural gas. These prices were not only lower than expected but also well below the realized prices recorded in the second quarter last year.

The reason for the low realized prices is the company's hedging policy, which includes buying and selling options to hedge against sharp moves in the prices of oil and natural gas. If prices fall below a certain price level or rise well above a target price, Chesapeake Energy pays up. In the second quarter, the company recorded a net loss of $213 million from these derivatives. Thus, Chesapeake Energy's realized price of oil (including realized losses derivatives) comes to only $85 a barrel, while the market price of oil was $103 a barrel. Realized natural gas prices were only $2.45 per 1,000 cubic feet of gas, while the average market prices reached $4.6 per 1,000 cubic feet during the second quarter.

Despite these low realized prices, the company has done well in reaching its quarterly production goals, lowering costs, and increasing its output for the year. These factors will keep driving the company's stock higher.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

TheStreet Ratings team rates CHESAPEAKE ENERGY CORP as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate CHESAPEAKE ENERGY CORP (CHK) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its robust revenue growth, impressive record of earnings per share growth, compelling growth in net income, attractive valuation levels and good cash flow from operations. We feel these strengths outweigh the fact that the company shows low profit margins."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The revenue growth greatly exceeded the industry average of 1.5%. Since the same quarter one year prior, revenues rose by 47.4%. Growth in the company's revenue appears to have helped boost the earnings per share.
  • CHESAPEAKE ENERGY CORP reported significant earnings per share improvement in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past year. We feel that this trend should continue. During the past fiscal year, CHESAPEAKE ENERGY CORP turned its bottom line around by earning $0.68 versus -$1.62 in the prior year. This year, the market expects an improvement in earnings ($1.97 versus $0.68).
  • The net income growth from the same quarter one year ago has significantly exceeded that of the S&P 500 and the Oil, Gas & Consumable Fuels industry. The net income increased by 632.8% when compared to the same quarter one year prior, rising from $58.00 million to $425.00 million.
  • Net operating cash flow has increased to $1,291.00 million or 39.71% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth rate of 18.80%.

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