Sinopec Is the Latest Beneficiary of Chesapeake Energy Corporation (CHK)’s Deflation

For the fourth quarter, Chesapeake’s profit dropped by 36.4% to $300 million from $472 million in 2011. Excluding one-time items, Chesapeake Energy Corporation (NYSE:CHK) earned profits of $0.26 per share beating estimates. Its average selling natural gas price, its primary product, in the quarter was $2.07 per thousand cubic feet, which is 47% lower from last year. Although natural gas prices were strong in Q4 2012, Chesapeake hedged 75% of its output to contracts that were set below market prices and could not be reflected in Chesapeake’s earnings.

With natural gas prices locked in, it was the company’s crude output, which increased by 69%, that drove Chesapeake’s financial growth. It has been increasing its focus on crude to reduce its exposure to natural gas, which accounted for 77% of the company’s total output, down from 82% in the previous year. However, this was largely ignored by investors, who are more concerned about the company’s management and its inability to extract full value from its overleveraged assets.  Any operational gains are vastly overshadowed by the deterioration of its balance sheet. Following the earnings release — post Feb. 21 — Chesapeake’s stock retreated 5.6% overall, including the 6.8% drop that came after the company announced the Sinopec sale.

Stock 1Y -24.91% -10% 0.41%
P/E N/A 16.6 9.0
EPS -1.46 4.74 9.7
Yield 1.7% 0.4% 2.6%
ROA -2.4% 2.7% 13.3%
ROE -3.3% 12.0% 28.6%

I’m not convinced that the best way to play the shale gas boom in the U.S. and Canada involves producers like Chesapeake or Exxon Mobil Corporation (NYSE:XOM) , though I love Exxon’s portfolio mix and its consistently high return on assets. It is a well-managed and well-connected company and the leader in this space. That said, I believe the real money will be made by those who transport the gas to where it needs to go. An ETN like the Morgan Stanley Cushing MLP High Income Index ETN (NYSEMKT: MLPY) is an interesting play pulling down a 7.55% yield on a portfolio designed to match the underlying index. While the natural gas market in the U.S. is supplied at a price well below the historic average I would be more interested in the transporters than the producers.

The article Sinopec Is the Latest Beneficiary of Chesapeake’s Deflation originally appeared on and is written by Peter Pham.

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