Thursday, January 18, 2007

Link: Chesapeake Energy Analysis

I like Chesapeake Energy as a contrarian play. Over the last year, natural gas prices have declined from last year's peak to about $6 per mcf due to mild winters and cool summers. Even if it gets much colder in the next few months, the current glut of NG supply may still keep prices depressed. Lower NG prices is a short-term risk to what I think is a long-term trend. The company's multi-year reserve acquisition binge has ended and management will now be devoting their efforts to drilling. I expect reserves to increase dramatically as unproven reserves are proven. This will further boost the present value of the company as presented in Eric Schleien's excellent post about the break up value of the company. Even though CHK has 2x more unproven reserves than proven reserves, the unproven reserves are valued at 1/2 the value of the proven reserves. In other words, proven reserves are 4x more valuable than unproven reserves according to this analysis. The analysis appears very conservative because historically 50% of unproven reserves are converted. Coupled with the potential for NG prices to increase, we have a very undervalued asset play.

I have a position in this stock and will be purchasing more under $28. For a second opinion, check out this post at Theo Wong's site. Note that McClendon did not actually make the $9 million dollar purchase; it was a stock grant.

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