Ever since management from Chesapeake Energy (CHK) issued a going concern warning late last year, investors have been pondering the chances of bankruptcy. With natural gas prices falling throughout the 2019-2020 winter season and the coronavirus crushing oil prices for a time, that premise has become almost a certainty. After a number of months where we’ve heard that the company was about to declare bankruptcy, this week’s events seem to be the first legitimate financial signal that the process is starting.
After the bell last Thursday (June 18), Chesapeake announced that it had skipped some interest payments that were scheduled for June 15th, this past Monday. The company now has a 30-day grace period before non-payment would constitute a default event. Perhaps even more important was the extra information that the company’s credit agreement has been amended, with the biggest change being the borrowing base reduced from $3 billion to $2.3 billion.
As the most recent 10-Q filing details, Chesapeake ended the first quarter of 2020 with less than $100 million in cash. However, it also had more than $9.5 billion in total debt. The company has a little more than $250 million in debt due the rest of this year, some of which is due July 1st. The company’s credit facility was its major source of financial flexibility, having an outstanding borrowing balance of $1.9 billion at the end of Q1. Thursday’s news of the $700 million cut for that credit facility substantially reduces that potential lifeline.
With oil prices rebounding a bit in recent weeks, and some highly speculative trading in very distressed names, Chesapeake shares rocketed to a high of $77.50 on June 8th before falling back to earth. Unfortunately, there is likely to be no long term value for the company’s equity. The balance sheet is in terrible shape, but take a look at the following hedge situation.
(Source: 10-Q filing linked above)
Part of the reason why Q1 revenues were so much better than expected is this year’s tremendous oil hedges. Unfortunately, the company does not have that protection in for next year, and the natural gas hedge situation is even worse. At current prices and likely significantly reduced production, the company will find it hard to produce any positive free cash flow. Debt investors are trying to get whatever they can, but that likely puts a zero value on the equity.
Chesapeake shares will likely remain volatile for some time. That’s primarily a function of having such a low float after the reverse split that happened in April. There could be some short term pops if we see oil and natural gas prices spike for a time, but it wouldn’t surprise me to see shares in the single digits again by the end of the month. This would seem especially likely if we get an actual bankruptcy filing rather soon, not just talk of it happening again and again. Investors should also be very careful if they see a large spike in shares, especially if it is due to high volume trading on the Robinhood platform.
In the end, this week’s missed interest payment likely signals that bankruptcy is just around the corner for Chesapeake Energy. The debt situation is not workable in this low commodity price environment, with the company unable to generate any meaningful cash flow. Unless we see a dramatic rebound in oil and or natural gas prices in the next few months, current shares will be basically worthless, so investors looking to get out should probably do so now.
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