Chesapeake Energy: A Buy at Current Levels

NEW YORK ( TheStreet) -- At the beginning of the month, Chesapeake Energy ( CHK) reported its second-quarter earnings. Total revenue for the country's second-largest producer of natural gas grew 38% to $4.68 billion, up from $3.39 billion previously and above market forecasts of $3.21 billion.

Adjusted after-tax net income came in at $334 million (51 cents per share), a strong improvement after the $3 million (6 cents per share) rise seen during the same period last year -- and roughly 10 cents per share higher than what was expected by analysts.

In its entirety, there were some weak points in the report, but when we look at Chesapeake's positioning relative to the industry as a whole, it is clear that the stock is a buy at current levels.

Chesapeake's second-quarter positives included improved cost reduction, a stronger balance sheet, and a better-diversified production mix. Liquid products made up about 25% of Chesapeake's output, which suggests that the company is making progress in its transition into oil from natural gas. At this time last year, liquids accounted for only 21% of overall productivity. Given the oil strength we are seeing in the current environment, this transition is likely to help pad Chesapeake's profit potential moving forward.

In the first half of this year, Chesapeake received $2.4 billion from asset sales (after dropping $11 billion in assets in 2012). Because of these sales and the company's expected strength in net operating cash flow (on gains in oil-related assets), Chesapeake should have no problem using its cash flow to fund its capital expenditure programs.

This marks a turning point for Chesapeake, given its longstanding record of overspending. In expenses, drilling and completion costs dropped by 35% (yearly basis), coming in at $1.6 billion for the quarter. Total leasehold and other capital expenditures also showed major improvements, coming in at $245 million (a reduction of 75%). Debt and liquidity problems also show marked improvement when compared to the end of last year.

But the biggest positive in the company's positive earnings report can be seen its nearly 45% growth in oil production. Chesapeake's Eagle Ford drill site generated 57,000 barrels in average daily output during the second quarter, an improvement of 32,700 barrels for the year. Given the consistent strength we are seeing in oil prices, this puts the company in its best position in many years. Operating cash flow from core assets rose by more than 50% (yearly basis), and when this is seen in conjunction with recent asset sales, the liquidity risk possibilities starts to look relatively insignificant.

For valuations, the stock's forward P/E is holding below 10, which sends positive signals given the sector average of 27. When we compare these valuations to the S&P 500 as a whole (16.7), the level of attraction starts to become more clear. Chesapeake's price-to-sales ratio is 0.93, where the rest of the industry stands at 5.4. CHK stock pays a dividend of $0.35, with a yield of 1.80%.

Overall, Chesapeake continues to show improvements in cutting costs and in solidifying its transition into more profitable sections of the market. This marks a key reversal period for a company that has traditionally had problems with financial discipline.

Relative valuation positioning within the industry suggests Chesapeake is poised for significant upside, and current price levels mark strong risk-to-reward areas for buy entries in the stock.

From here, watch the company's commitment to achieving stricter financial discipline and in growing its asset base. These elements should continue to mark the key drivers for future gains.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Richard Cox is based in China, and has lectured at several universities there on international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of Web sites, including MarketBulls.net, Seeking Alpha, FX Street and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.