Chesapeake Energy Corporation

Chesapeake Energy Corpo proportionalityn (NYSE CHK), headquartered in Oklahoma City, Oklahoma, owns 1.1 meg cubic feet equivalent (tcfe) of proved rock veget able fossil oil and shooter reserves, one of the largest inventories of onshore U.S. raw(a) gas Chesapeake Annual Report, 1998, p. 1. Recently, Chesapeake finished the transformation from an hawkish exploration federation focused on developing short-reserve life, to a lower-risk, protracted reserve life immanent gas producer.Chesapeakes trading operations atomic number 18 focused on developmental drilling and producing property acquisitions. These operations be severe in three major beas the Mid-continent, the onshore Gulf of Mexico and remote northeastern British Columbia, Canada Chesapeake Annual Report, 1998, p. 1.Aubrey K. McClendon is Chesapeakes Chairman of the Board, Chief executive Officer and Director. tom L. Ward is the President, Chief Operating Officer and Director. McClendon met cofounder Tom Ward in the 1980s. Both were in cipherent oil producers they grouped up in 1983 Morgenson, p. 2. They each draw more than 16 course of studys of experience in the oil and natural gas assiduity. All other members of the management team have multiple years of experience in the intentness.Chesapeake has concentrated on expanding its holdings in natural gas since the companys incorporation in 1989. Chesapeake thinks that natural gas will be the sack choice of the twenty-first snow. The company has been highly competitive in both its exploration activities and efforts to emergence its inventory of undeveloped leasehold land. This combination should enable Chesapeake to remain a competitive force in the energy producing industriousness.New technology in the oil and gas industry has made exploration and production more networkable. This is tonality for the survival of American businesses that compete with OPEC and other foreign cartels that have rattling low production be. New tech nology, including three-dimensional imaging, which has greater resolution than the previously existing technology, will enable Chesapeake to detect reserves more completedly. Also, plain drilling has enabled companies to drain more than one reserve at a time. With profits proceed to be squeezed within this industry, new technology is requirement to help American businesses compete on a global scale.The oil and gas industry is truly a global market. The industry boosted gains in 1999 from increased production efficiency and a minify in the up-to-the-minute supply. U.S. firms, a immense with OPEC, have voluntarily reduced their gist production, which has increased the price. OPEC presently supplies approximately 40% of the world oil production. If OPEC chooses to produce at a lower output, Chesapeake could easily increase production with its low production be and huge reserves. Many other nations are emerging as competitors, much(prenominal) as the former Soviet Union and Latin American countries. The continuing increase in supply from other nations would potentially saturate the market, causation lower prices and lower profits. Demand is expected to full only around more than two percent through the year 2005.The outlook for this industry is for increased competition domestically (from smaller companies) and internationally from emerging nations. The U.S. has shining technology, which will help keep profits up as supply increases and demand remains sexual intercoursely constant.Natural gas makes up 72% of Chesapeakes revenue. They usually sell the product to third parties and are non dependent on any one buyer. Less than 10% of their revenues are generated from two buyers.Governmental Regulations Operational and Labor RelationsThe oil and gas industries are subject to considerable government regulation. These laws and regulations are primarily enjoin toward the handling and disposal of drilling and production waste products and waste create d by water and air pollution control devices Chesapeake 10-K, 1998, p. 10. The oil and gas industry is accountable to numerous government agencies, including the Environmental Protection Agency, the division of the Interior, the Department of Energy, the State Department and the Department of Commerce. Virtually every aspect of operations is subject to complex and ever changing regulations.The oil and gas industry is tightly regulated in regard to beat back relations by government department and agencies, including the Occupational Safety and Health Association (OSHA) and the study Labor Relations Board (NLRB). Some bring ups have their own state sponsored occupational safety plans, while the remainder must comply with national OSHA regulations. Some of the topics covered under OSHA include personal protective equipment, fantastic communication (HAZCOM) and safety process training.Chesapeake had 453 employees as of March 15, 1999. None of these employees were delineate by orga nized labor unions. The company considers its employee relations to be skilful Chesapeake 10-K, 1998, p. 13. Unocal (NYSE UCL) employed 7,880 people as of December 31, 1998, of which 575 were represented by respective(a) U.S. labor unions Unocal 10-K, 1998, p. 12.Both companies are subject to new laws and regulations regarding the environment and labor. Chesapeake and Unocal cannot signal what adverse financial conditions the new laws and regulations will bring. However, short-term and long-term be will increase as companies improve existing operations to get under ones skin and remain compliant with government regulations. As a result, all companies in petro-chemical industries are experiencing tremendous difficulty operating profitable businesses. Several businesses have ceased operations as a result of increased regulation linked with poor profit margins.Chesapeake is at a higher risk regarding this scenario since close to of its operations are domestic. Unocal, although a U.S. based company, operations are concentrated primarily overseas, and therefore experience increased leniency regarding environmental and labor regulations.During the last two years, Chesapeake Corporation took a significant hit in terms of earnings, stock price and reference ratings. Positive 1996 earnings sour to a loss in 1997 and tumbled to a bigger loss of $10 per share in 1998. This earnings decline caused the stock price and credit rating to plummet. The company also faces a class action drive stemming from alleged violations of federal securities laws. Top management and directors are accused of using insider information to sell personal holdings in the company at unnaturally inflated prices.Chesapeake had very disappointing years in 1997 and 1998 as demonstrate by the fall in the stock price. The company underwent a straightforward repositioning to increase natural gas holdings and reduce risk. As a result of this repositioning, Chesapeake incurred considerable deb t and is dependent on the market prices of oil and natural gas to increase, and in effect, improve profit margins. Additionally, in 1997, Chesapeake changed their fiscal year end from June 30th to December 31st.As part of the repositioning, Chesapeake increased long term debt over $ cd million to a entireness of $920 million, join with a short-term indebtedness of $25 million. This increased borrowing drastically reduced the companys ability to obtain extra support. well-worn & lights and Moodys placed Chesapeake on check into with a negative outlook. The ability to impinge on obligations for this additional debt will depend on the production and financial performance of the company, market prices of oil and natural gas, and general economic conditions.Common Size Income Statement AnalysisChesapeake had an exceedingly large write-down of assets ( legal injury) as a result of reduced oil and gas prices during the past few years. This charge increased operating tolls by over $1.2 one thousand million during 1997-98 with 72% of that cost coming in 1998. The asset write-down, combined with expense increases in production, marketing and bet, were the main contributors of center operating costs to be over three times total revenue. The result was 1998 EBIT of ($920) million, and a non-existent ROE, since the company had a net loss come up $1 billion. Unocals ROE was 5.9% in 1998 and 25.1% in 1997.The impairment cost reported by Chesapeake is questionable because of the very large quantity that was charged. In perspective, Unocal with over $5 billion in property assets recorded an impairment charge of $97 million during 1998. If oil and gas prices rise in the near future, the impairment costs may be reversed big(p) the impression that the company is doing very well. Future investors of Chesapeake equities should consider this fact front to making any investment decisions.Chesapeake had a $140 million decrement to both sides of the balance sheet. The repositioning of the firm focused on change magnitude inventory of natural gas reserves, the enkindle of choice for the 21st century 1998 Annual Report, pg. 18. Oil and gas properties nearly doubled from 1997 to 1998, totaling $2.2 billion. However, nearly $1.6 billion was depreciated, depleted and amortized. Additionally, bills decreased nearly $100 million, short-term investments were negated, and paid-in bang-up exceeded $1.1 billion over the past two years to provide additional currency for purchases of gas reserves. As a result, total property, plant and equipment was 85% of total assets in 1998 compared to 77% in 1997. In comparison, Unocals PP&E was 66% and 64% of total assets respectively.Long-term debt increased over $400 million in 1998, totaling $920 million compared to $510 million in 1997. The $920 million was 113% in relation to total liabilities and owners equity of $813 million. In 1998, inclineing liabilities were $131 million compared to menstruation ass ets of $118 million. This resulted in a reduced current ratio of .90 from a 1997 ratio of 1.42. The Unocal current ratios during 1998 and 1997 were 1.01 and 1.29 respectively.Chesapeake has relied primarily on gold flow through financing activities during the past few years. immediate payment flow from operations was approximately $95 million in 1998 and $180 million in 1997, while property flow from financing was $365 million and $278 million respectively. Sales accounted for $378 million in 1998 and appear to be rising approximately 35% annually from 1996 and 1997. However, an accurate comparison is unavailable because of the change in the companys fiscal year end.Low oil and gas prices compel Chesapeake to borrow, sell equity, and liquidate short-term investments in order to hide operations and invest in oil and gas properties. The company is dependent on the rise of prices during 1999 to continue operations and provide shareholder wealth. The company has several restriction s from being able to borrow additional funds. Additionally, the price of stock has dropped from a high of $34 in 1996 to a low of $.63 in 1998. This has further reduced the companys ability to generate capital.The current ratios for Chesapeake Energy are as follows 1.00 (June 96), 2.03 (June 97), 1.42 (December 97), and .90 (December 98). Current liabilities remained constant over this period, ranging from a high of 19% (June 96) to a low of 15% (June 97), with the current level at 16% of total assets. Extreme levels of change in current assets caused the current ratio to vacillate drastically. Current assets declined from a high of $297 million (31% of total assets) to a current low of $117 million (15% of total assets). This decline in current assets caused the constipation of the current ratio.The acid test ratios are as follows .94 (June 96), 2.00 (June 97), 1.37 (December 97), and .81 (December 98). As previously mentioned, current liabilities remained constant. Net accounts receivable remained flat as a dower of total assets 9% in 1996, 7% in 1997 (Both June & December), and 9% in 1998. Marketable securities were interchange off during the past three years, decreasing from 11% ($104 million) of total assets to zero. cash decreased from 13% ($124 million) of total assets in 1997 (both June & December) to 4% in 1998. The combination of severe decreases in both coin and vendable securities are the reasons that the acid test ratio decreased so dramatically.The quickly ratios are as follows .96 (June 96), 2.00 (June 97), 1.38 (December 97), and .86 (December 98). As mentioned previously, current liabilities remained constant and current assets declined. As with the current ratio, the main reason for the deterioration of the quick ratio is the act loss of current assets.The above ratios and the reasons for their poor trends indicate Chesapeake is currently in a liquidity crisis. This, in combination with the increased debt liabilities, is an extreme warning to both investors and management. This condition also adds to the suspicion that assets are being sold off to fund current debt obligations.The firms ability to fulfil its obligations with exchange, as they come imputable, is approximated by the cash flow liquidity ratio. As previously mentioned, solvency improved and then deteriorated as indicated by the current and quick ratios. The trends are confirmed when looking at cash flow. From 1995 to 1997, Chesapeakes cash flow liquidity improved from 1.47 to 1.8. 1997 to 1998 showed a large drop in liquidity from 1.8 to 0.95. The companys financial statement data gives an recital as to why.From 1995 to 1997, short-term solvency improved from 1.47 to 1.8. When looking at the data, cash from operations bloom from $55 million in 1995, to $139 million in 1997. The 1997 rise was due to a change in the accounting period. During this same period, cash on hand rose from $56 million to $123 million and marketable securities rose from zero to $13 million. While cash was increasing, current liabilities rose from $75 million to $153 million. Current liabilities doubled during this period, while cash flow increased 150%. The larger increase in cash flow, relative to short-term obligations, accounts for the improvement in solvency during the 1995 to 1997 period.During the 1997 and 1998 periods, liquidity deteriorated as shown by the decrease in the cash flow liquidity ratio from 1.8 to 0.95. The data indicates that cash from operations dropped approximately 32% to $95 million. When looking at the Cash Flow Statement, the large decrease in operating cash is in the first place due to the large net loss incurred during the period. At the same time, cash dropped 76% to $30 million while marketable securities fell to zero. oft of the cash appears to have gone to fund the companys payables and accrued liabilities. Current liabilities were reduced 15% to $131 million. The larger simplification in cash flow relative to cu rrent obligations accounts for the deterioration in short-term solvency.The cash flow data confirms that Chesapeakes liquidity suffered severe deterioration. A reduction in current liabilities is a good sign, but the little amount of cash generated and being used to fund current obligations is not enough. Cash assets are being used to fund these obligations as well.In comparison to the industry debt ratio of .31, Chesapeake ended with a debt ratio of 1.31 in 1998 compared to .71 in 1997. The long-term debt to total capitalization ratio increased from .64 in 1997 to 1.37 in 1998, while the industry total was .44. The tremendous increase in debt was due to significantly lower oil and gas prices during the past three years, and a failed drilling venture known as the Louisiana Trend. The company was forced to liquidate assets and take on a substantial amount of debt to meet operational expenses and increase oil and gas field reserves. Chesapeake was added to the Standard & Poors Credi tWatch with negative implications Yahoo Finance, Nov. 14, 1999 in December of 1998.The low price of fuel during fiscal years 1996 through 1998 was the primary reason for Chesapeakes troubles. The debt incurred has covenants curb the company from seeking additional debt and from paying dividends to preferred stock holders. read/write head on a large portion of the outstanding debt is not due until 2004 allowing the company time to improve operations. This will also give fuel prices a chance to rise, which is determinant to the companys survival.The industry average for times interest earned is 5.2, while Chesapeakes operating profit was ($856) million. The ratio equated to well below zero in 1997 and 1998. In 1998, interest payments were more than $68 million.The financial leverage index could not be computed since there was not a return on equity. Chesapeake overextended their credit by substantially financing with debt and has jeopardized their ability to make obligated payments for their debt and fixed costs.