A Good Name in Natural Gas

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

The New York Sun

JOHN BUCKINGHAM
CHIEF PORTFOLIO MANAGER
AL FRANK FUNDS
COMPANY: Chesapeake Energy

TICKER: CHK (NYSE)
PRICE: $29.05
52 WEEK RANGE: $22.50-$40.20
MARKET CAPITALIZATION: $11.1 billion

John Buckingham is the chief portfolio manager of the California-based Al Frank Funds (VALUX). Mr. Buckingham is also the editor of the Prudent Speculator and president of Al Frank Asset Management. Mr. Buckingham spoke to Katharine Herrup of The New York Sun about why Chesapeake is not as volatile a stock as one might think.

What does the company do?

They are the second largest producer of natural gas in the U.S. They are headquartered in Oklahoma, and their primary operations are in Texas Louisiana, Arkansas, and Oklahoma They are an onshore driller.

Why do you like the stock?

The attraction for us to the company is manyfold. The chairman of the company has been an avid purchaser of the stock. Just in June, the chairman Aubrey McClendon, bought 700,000 and now he owns over 25 million shares of the company. He paid for the latest 700,000 share purchase in the $28-29 range. And it’s not an option exercise – he is putting his own money where his mouth is. Seldom do you see a chairman buying this quantity of stock, it is a substantial commitment and an added benefit of buying into this company – you are on the same side of the chairman who is in good tune with this industry.

This company has grown dramatically since it went public in 1993 via acquisitions. They have been able to make intelligent acquisitions at favorable times when natural gas prices were relatively low. There are still opportune investment opportunities out there, so they are still buying the rights to oil and gas wells. They have an interest in 32,000 oil and gas wells. About 92% of that is natural gas, meaning 8% is oil.

The other intriguing thing about the company is that the price of natural gas has gyrated all over the place, but Chesapeake was able to hedge a substantial piece of their production at substantially higher prices than where natural gas is today. Natural gas has been down trending in the past 3-4 months, so Chesapeake’s stock is doing the same as well, but they have hedged 80% of their 2006 production at an average price of $9.37 – the price of natural gas today is around $6 – and in 2007, they have hedged 57% of their production at $9.90, and 41% of their 2008 production at $9.02.

What do you think the stock is worth? Do you expect its value to increase?

The stock is trading at around nine times earnings. The company has exhibited growth and ability to effectively operate in a volatile industry so it should trade for more than nine times earnings. Our target price for 12 months is $36 and for 3-5 years it’s $60. We’ve owned the stock for about nine months or so, and it hasn’t done anything for us yet which is why we like it.

How do you expect the natural gas industry to perform going forward?

The price of oil has stayed very high whereas natural gas has had its big spike, and it has come down recently. If there is a cold winter, natural gas prices will go up. Also, if you are environmentally conscious, natural gas is a clean burning fuel.

Is it a good time to buy?

Absolutely given that the stock price has declined over the last several months.

What are the risks?

Commodity prices are always volatile, but Chesapeake has done a very good job of controlling the risk in a commodity business. They don’t have any risk associated with offshore drilling, where drills can get blown over by a hurricane. There is no risk with drilling in foreign countries since Chesapeake only operates in the U.S., so there is no geopolitical unrest. When you hedge so much of your production, I just don’t see a lot of risk there.


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