NEW YORK (The Street) -- The investment community is taking a sharper interest in Chesapeake Energy (CHK) since a downgrade Tuesday, trying to figure out this controversial energy giant.
CHK, whose shares closed at $25.85 Wednesday and trades on average daily volume of over nine million shares, have taken an 11% "haircut" since the stock hit its 52-week high of $29.06 on Nov. 4. For the year to date, shares are down nearly 6%.
On Tuesday the analysts at Bank of America downgraded CHK to neutral from buy and reduced the price target to $31 from $36. There had been a "recovery thesis" underlying the stock's rating when the share price was significantly lower. That recovery thesis has evidently played itself out.
The Oklahoma City company is the second-largest producer of natural gas, the 11th largest producer of oil and natural gas liquids and the most active driller of onshore wells in the U.S., according to its Web site.
The extent of its operations and areas of exploration and development are downright impressive, including holdings in the Eagle Ford, Marcellus, Haynesville/Bossier, Utica, Granite Wash, Cleveland, Tonkawa, Mississippi Lime and Niobrara unconventional liquids and natural gas shale plays. CHK also controls large marketing and oilfield services operations through its subsidiaries Chesapeake Energy Marketing and Chesapeake Oil Services.
Sometime between Feb. 17 and Feb. 21 the company will announce earnings results for the fourth quarter of 2013, and expectations are high. The average analysts' estimate on earnings per share for the quarter is an increase of around 65%. That may help explain why its share price had appreciated about 48% in the past year.
The same community of analysts who cover CHK are anticipating sales growth for the fourth quarter to come in at around a 31% increase. Revenue for the year is expected to be over $17.3 billion, up almost 78% during the time period from the 52-week low of $16.37 to the 52-week high of $29.06 on Nov 4. The company made great strides in 2013 to improve efficiency across the board, including steps to increase free cash flow. At the end of its third quarter its trailing 12-month (TTM) levered free cash flow was a minus $3.6 billion.
By Sept. 30, shares of CHK looked very cheap, with a book value of over $20 and a price-to-earnings-to-growth (PEG) ratio (five-year expected) of only 0.29. That's why the following one-year chart does a good job of telling the story of the stock price and what helped to drive it up so powerfully.
CHK data by YCharts
That green line is CHK's diluted quarterly EPS, and what went way up in the second quarter of 2013 certainly fell down hard in the third quarter. Part of the reason for this may have to do with some of the negative repercussions from CHK selling off large chunks of its multiplicity of holdings.
For example, in conjunction with a number of transactions to sell its pipeline business for more than $4 billion, the company obligated itself to transport a specified amount of natural gas on lines using Access Midstream Partners (ACMP), which now owns part of the pipelines that CHK sold. There's a costly catch to this commitment.
That's because Chesapeake is cutting back on drilling for new wells near ACMP's pipelines, and thus the company isn't using the pipeline capacity it had reserved. It could now have to pay for this obligation whether it uses it or not. That could add up to a painful $400 million that CHK would owe Access over the next five years to cover any shortfalls.
The new CEO of CHK, Doug Lawler, and his executive team have promised to address these issues, curtail spending and improve the company's bottom line. As the chart above plainly illustrates, the future of CHK and the value of its shares will depend on those expenses going down, revenue going up and EPS doing the same.
Investors will be listening carefully to the next earnings conference call, and I would encourage investors who own shares or are looking to accumulate CHK to be cautious until all the facts are on the table and in the spotlight.
I'm not saying that CHK isn't a worthwhile speculation at current price levels. What I am saying is that Chesapeake Energy is only offering a 1.35% dividend payout to reward investors who don't know for sure if the company can cut costs enough while it ramps up production.
Investors also need more clarification about its obligations from the past sales of its now smaller dominion. Those answers will probably have to wait until the third week in February, and that is well worth the wait.
At the time of publication the author had no position in any of the stocks mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.
This article was written by an independent contributor, separate from TheStreet's regular news coverage.