Chesapeake is a name we follow closely, which has had mixed fortunes since the slump in energy prices over 12 months ago. More recently, Chesapeake bonds have been underperformers in Q3 against other energy names, with all of its benchmark bonds significantly lower across the curve. Many investors could be wondering whether current bond valuations create an attractive entry point or whether there is potential for further downside from this point forth.
Following earnings releases in mid-summer, it became increasingly apparent that Chesapeake’s short term fortunes rest on a number of key factors, namely; the prices of oil and gas, the execution (and execution rate) of asset sales, the potential of renegotiating ongoing contracts at favourable terms as well as the potential of renegotiating a secured revolver at more favourable terms.
Over the course of 2015, Chesapeake has moved from a rising star candidate to a high beta name, given the sharp correction in the price of oil which adversely impacted the company’s credit metrics. S&P have in fact downgraded its corporate credit rating for Chesapeake by two notched to BB- on 02 October 2015.
There have been several “credit positive” news items over recent weeks which we deem necessary to highlight.
• Chesapeake has recently successfully managed to renegotiate new fixed-fee arrangements in the Haynesville and Utica shales. Management expects the impact on CHK's annual to be EBITDA an improvement of ca $0.2bn, equivalent to ca a 0.5x improvement in expected leverage for 2016. This news is a significant positive, both quantitatively and qualitatively as its shows management’s willingness to renegotiate midstream contracts. Despite such moves, we would expect the need for asset sales to shore up the company's liquidity position.
• Chesapeake Energy Corp has recently announced that it will be reducing headcount by 740, bringing its total number of employees down to 4,000, with a one time-charge of $55.5 million as a result of this structural move (to be reflected in Q3 results). This leads us to believe that it is only a matter of time until management will announce the sale of additional assets following the reduction in its workforce. Company CEO stated on 29 October 2015, "While this was extremely difficult, we are acting decisively and prudently to enhance the long-term competitiveness and strength of Chesapeake. Over the past year, we have taken significant actions in response to the low commodity prices by reducing our costs and decreasing our capital spending."
• Chesapeake announced on 30 September 2015 that it has amended its five-year, $4.0 billion revolving credit facility agreement maturing in 2019 with its bank syndicate group. While Chesapeake’s obligations under the facility are secured, the amendment gives Chesapeake the ability to incur up to $2.0 billion of junior lien indebtedness. The key takeaways from this move are; (1) moving to a $4.0bn senior secured RCF from a senior unsecured RCF; (2) Borrowing base confirmed at $4.0bn; (3) Previous total leverage financial covenant of 4.0x trailing 12-m EBITDA has been suspended; and (4)two new financial covenants: (i) a senior secured leverage ratio of 3.5x to 2017 and 3.0x thereafter and (ii) and an interest coverage ratio of 1.1x through the first quarter of 2017, increasing incrementally to 1.25x by the end of 2017.
Chesapeake’s CFO added that “this amendment to our existing revolving credit facility gives Chesapeake greater flexibility and access to our liquidity. The new senior secured leverage ratio which begins at 3.5x and new interest coverage ratio which begins at 1.1x coverage provide us with full access to the facility’s capacity under current market conditions. Along with opportunities for additional proceeds from potential asset divestitures, joint ventures and farm-out agreements, and an estimated reduction in our 2016 cost structure of more than $200 million through production and G&A cost improvements, this amendment places Chesapeake in a position of greater strength and flexibility.”
We remain aware that near term risks in CHK credit remain skewed to the downside; however we take comfort in management’s efforts in shoring up the company’s liquidity metrics once again. We view the recent renegotiation of the RCF as a clear credit positive, particularly for the ultra-short dated bonds which seem to be better positioned to take advantage recent developments.
CHK has clearly had issues, over the past twelve months, on the efficiency of its rigs and was impacted by costs, bringing down margins and average realisation volumes and prices. Never the less, we remain of the opinion that, at current levels, investors are well compensated for the risk undertaken. We would refrain adding onto the longer dated bonds for the time being given the hefty redemption schedule but view the curry entry point for the 17s in € and 18s in $ to offer an attractive entry point on a risk-adjusted basis, for a short-term play.
This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.