Chesapeake Energy (CHK) reported a fiscal first quarter that was a major disappointment. The company ended up taking a massive $5.75 billion loss on the quarter or $9.63 per share, because of a massive $6 billion impairment charge from the declining value of its oil and gas properties, which represents 16% of its asset value as of 4Q08. Excluding the one-time charge the company made 46 cents per share in the quarter which was below analysts expectations even though revenue was ahead of projections. Chesapeake is America’s largest producer of natural gas, and as such it has been particularly hamstrung by the decline in energy prices. The company’s stock was trading in the $70’s when gas was selling around $13/mmbtu, but the price of gas cratered to around $3 and so did Chesapeake’s stock.

Clearly, the massive one-time charge is making investors nervous as the stock dropped more than 10% today. Coming into the day, the stock was up 41% year to date and had greatly outperformed many of its peers including XTO and EOG. The $6 billion one time charge sent a jolt into Chesapeake stock that it was probably coming at one point or another anyway. Interestingly, the company made a bullish call on some of its gas price hedges by monetizing 20% of its options for 2010. The company is still expecting production to be up slightly (1%-2%) in 2009 but that production in 98% hedged. As of the 1Q report, the company has pulled back on its hedges for 2010 to just 55% of production which is projected to grow more than 10% in 2010. This could entail more risk for the company, but they are taking action to get more bullish on the price of natural gas in 2010. Obviously, if the “green shoots” in the economy begin to take hold and we start to see growth there is a great chance that gas prices will go higher.

Ockham currently has a Fairly Valued stance on Chesapeake shares, but the decline in price today is starting to make the stock look more appealing. Earnings have not been overly impressive, but CHK is selling well below its historically normal price-to-sales range. It was disappointing to see that CHK was not cutting costs as successfully as some of their competitors, and that is something we will be watching out for as the low price of gas necessitates some cuts. We are not yet ready to upgrade the stock, especially as the market still needs to digest the massive write-down on the first quarter, but if shares continue to decline down to about $17 per share then it is will most likely warrant an upgrade.

Ockham Research