Chesapeake Energy Misses on Revenue, Wins Upgrade Anyway

By Rich

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

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On Thursday, oil and gas exploration and production company Chesapeake Energy (NYSE: CHK) announced its fiscal Q4 and full-year 2016 earnings results. The short story here (as related by is that the company appears to have met analyst estimates on earnings (earning the consensus estimate of $0.07 per share), but missed on revenue -- booking $2.02 billion when $2.07 billion had been expected.

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Regardless of the miss, Chesapeake Energy stock is rising in Friday trading, helped out by a just-in-time upgrade from the kindly analysts at Swiss banker UBS. But does Chesapeake deserve the upgrade?

Let's find out. Here are three things you need to know.

1. Earnings

In at least some respects, Chesapeake had a pretty decent year in 2016. The company raised cash by selling off properties worth about 73,500 barrels of oil equivalent (BOE) production per day. But it maintained production at the properties it retained at an average rate of about 635,000 BOE per day. At the same time, Chesapeake cut average production expenses by 28%, and reduced transportation costs by 7%. The company grew its proved reserves of oil and natural gas by 14%, and replaced 249% of the BOE it produced in the year with newly discovered reserves -- guaranteeing its ability to meet world energy demands should they increase in the future.

From a financial standpoint, on the other hand, revenues declined 38% due to continued weak commodity prices, fewer producing properties (so less total production), and "unrealized hedging losses." Oh, and Chesapeake also recorded a loss of $6.39 per share. Not good.

2. An upgrade

Reacting to the news, investors have sold off Chesapeake by nearly 6%so far this week. But on balance, UBS found the company's bad news/good news report modestly encouraging, and decided this morning to upgradeChesapeake stock from sell to neutral. The analyst was especially pleased with Chesapeake's "improved liquidity" and increase in reserves -- but was less thrilled with management's guiding toward lower production in Q1, which UBS called "well below consensus."

What finally tipped the scales in Chesapeake's favor, though, in UBS' mind, was the fact that Chesapeake "has fallen below our price target to a fair value" of less than $6 a share. At today's prices, UBS sees less risk in the stock.

3. Back up a bit. What was that about guidance?

Chesapeake actually released guidance for the current year more than a week beforeearnings came out. In it, management told investors to expect production declines of as much as 3% (not counting lessened production from continued asset sales), with production weighted roughly 75-25 toward natural gas, and away from oil and natural gas liquids.

Management did not promise to hit any particular revenue or profit targets. Management did note, however, that it plans to ramp up capital expenditures this year to anywhere from $1.9 billion to $2.5 billion in order to "position Chesapeake for significant production andearningsgrowth and cash flow neutrality in 2018."

Final thought: What does that mean for investors?

Chesapeake may not be giving earnings guidance, but according to data from S&P Global Market Intelligence, the roughly two dozen analysts who follow Chesapeake Energy expect to see the company pull out of last year's earnings dive into the red ink and earn a profit this year -- $0.77 per share. By 2019, they expect to see the company earning more than $1 a share pretty consistently.

Those are just the GAAP accounting numbers, however. Real cash profits could be a whole lot harder to come by. For example, this year, analysts expect Chesapeake to generate more cash from operations than it did last year, but still only $1.7 billion -- not enough to generate positive free cash flow if capex spending is going to run north of $1.9 billion. Expectations for negative free cash flow continue into 2018, with the company only emerging into real cash positivity in 2019.

Long story short: If you want to buy Chesapeake Energy stock today in hopes that, at less than $6 a share, the stock will look like a bargain when the company reports profits of $0.77 later this year -- well and good. Just know that whatever its income statements say, Chesapeake is probably going to be burning cash and piling up debt for most of the rest of this decade. Despite its upgrade today, UBS still doesn't think this is a situation worth buying into.

And neither do I.

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Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.