Chesapeake Is Betting On The Haynesville

Apr. 20, 2023  Geoffrey Seiler seekingalpha.com

Summary

• CHK is favoring its Haynesville acreage over its Marcellus acreage in anticipation of LNG growth in 2025.
• Recent Eagle Ford dispositions give the company a clean balance sheet during a period of low nat gas prices.

• In addition, the company has nice hedge book as it waits for an opportunity in 2025.

Chesapeake (NASDAQ:CHK) is betting on the Haynesville and LNG growth to power results in 2025 and beyond. It has hedges in places and a strong balance sheet as it waits to get there.

Company Profile

CHK is a natural gas focused E&P. Earlier this year, the company sold parts of its Eagle Ford assets for over $2.8 billion in two separate transactions as it looks to exit the oil basin. It will now focus on natural gas basins in the Marcellus and Haynesville Shales.

In the Marcellus, CHK has approximately 465,000 net acres. About 54% of its 2023 production will come from the basin. For 2022, it had 103 gross wells (59 net) that produced 670 Bcf of natural gas.

In the Haynesville, the company has approximately 370,000 net acres. About 43% of its 2023 production will come from the play. For 2022, it had 83 gross wells (61 net) that produced 588 Bcf of natural gas.

Risks and Opportunities

As a natural gas producer, not surprisingly, the price of natural gas plays a huge role in CHK's results. Unfortunately for CHK and other natural gas producers, prices have collapsed from their 2022 highs. Prices initially surged last year due to the Ukraine-Russia war while gas flows into Europe declined after the Nord Stream pipeline was hit by explosions in September. However, a warm winter throughout the U.S. and Europe hampered natural gas demand, and prices declined precipitously.

For its part, CHK says its natural gas wells have a low average breakeven of $2.07 mcf and that it can get an over 90% average IRR at $3.00 mcf. While natural gas futures are currently trading under $3 until November, CHK has hedged between 55-60% of its production this year with floor prices above $3.00. It also has 30-45% of its 2024 production hedged at floor prices above $3.58.

CHK management expects natural gas prices to remain constrained until the end of 2024, as Permian associated gas hits the market due to better takeaway. However, it's looking for LNG growth to shift the supply-demand dynamics towards the end of 2024.

Discussing gas prices and supply-demand dynamics of its Q4 earnings call, CEO Domenic Dell'Osso said:

"Our macro outlook for gas hasn't changed. We are very bullish, the long-term natural gas fundamentals, and we've been cautious to 2023 setup for quite some time, and we've referenced that throughout last year. We noted that the supply-demand dynamics were trending in a manner that suggested supply was going to outpace demand. That has clearly happened and then has been exacerbated by what's been a pretty low demand winter weather set up. In terms of near term, I think we're at a pretty interesting point. We're making some changes to our program. We've seen a handful of others make changes to their program, hard to really know what the rest of the industry will do. You have variables like the associated gas from the Permian that as pipeline capacity comes on, that gas is going to show up to market, and you don't really have any structural demand growth for at least a year. And really in the end of '24 and into '25 is where you start to expect LNG export capacity to expand and so that's how we're going to think about what our production profile should do. We should be flat to down a little bit because the market is currently oversupplied until that structural demand growth shows up. …

"We are very bullish in the long-term fundamentals. We think that the projects that are coming online will represent true incremental demand, the demand for natural gas internationally with the competitive economics of shale gas in the U.S., is strong. We expect it to remain strong."

Given management's bullish outlook on future LNG growth, the company is actually running more rigs in the Haynesville (2) than it is in the Marcellus (1) this year. With close proximity to LNG facilities in the Gulf, Haynesville has been a resurgent play the past few years. If this demand develops, it will be a nice opportunity for CHK in a few years, given its strong position in the play.

Natural gas companies can often structure LNG contracts based on higher international pricing, and 15-20% of CHK's total volumes are currently being priced off international indices. The company recently announced a long-term supply agreement with Gunvor to supply LNG starting in 2027 based on the Japan Korea Marker.

That said, the Haynesville is not the low-cost play that the Marcellus is, and has become more the natural gas swing basin over the past few years. On its Q4 call, natural gas producer Antero (AR) noted that since 2011 that every time natural gas prices have fallen below $3 that rig counts in the basin have declined meaningfully. Meanwhile, with inflation, it thinks the breakeven might be up to $3.50-4.00.

With its hedge book, CHK can walk that line of directing more CapEx towards the Haynesville than the Marcellus with an eye on 2025, but it carries risk if these LNG projects get delayed or demand doesn't materialize. However, with the regulatory difficulties of getting new pipes out of the Northeast down South, I can understand its bet.

Given its recent bankruptcy filing in June 2020 and the death of its founder and then CEO Aubrey McClendon a day after he was charged with rigging bids for oil and gas leases, CHK can be a bit of a controversial name. However, with the recent Eagle Ford asset sales, the company will be about net debt neutral. It should generate free cash that it can put to work buying back more shares. The company also pays a 55-cent quarterly base dividend and a variable dividend, which can go up or down with natural gas prices. It should be able to pay out bet the base dividend, which it says it needs to see gas at $2.40 mcf. This is just above where natural gas prices are currently, but it has hedges and the future strip is higher.

Valuation

CHK trades at 3.9x EBITDA based on 2023 analyst estimates of $2.83 billion. Based on the 2024 consensus of $2.89 billion, the stock trades at a 3.8x multiple. The EV takes into consideration the cash CHK will get from its Eagle Ford acquisitions.

Of course, the price of natural gas and NGLs can change the actual results immensely. Interestingly, analysts see 2025 EBITDA jumping to $3.7 billion, which is when LNG projects in the Guld are expected to come online.

When taking into account its asset sales, CHK trades at a discount to its natural gas E&P peers, which typically trade at 5-6x multiple.

Conclusion

CHK is betting big on the Haynesville and future LNG growth. While not without its risks, that's not a bad bet. There will a difficult period until we get that late 2024, early 2025 period when LNG projects get up and running, but the company has a pretty good hedge book in place and a rock solid balance sheet after selling its Eagle Ford assets.

Trading at a discount to its Appalachia natural gas peers, I think the stock should have some upside from here. A $110 price target would be about a 5x multiple on 2024 analyst EBITDA estimates, with much more upside potential if LNG export capacity and demand increases beyond 2024 as the company is predicting.