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We reaffirmed our Neutral recommendation on Chesapeake Energy Corporation (CHK - Analyst Report) on Mar 12. The reiteration was backed by its stronger-than-expected fourth quarter earnings and improved oil production profile. However, these positives were balanced by a natural gas weighted production volume.

Why Kept at Neutral?

On Feb 21, Chesapeake − an independent oil and gas company − reported adjusted fourth quarter 2012 earnings of 26 cents per share, beating the Zacks Consensus Estimate by almost 86%. The outperformance came on the back of improved oil production.

Given the downtrend in natural gas prices, the company aims to spend most of its capital outlay (86% of the total 2013 capex) to drill liquids-rich plays. It plans to invest heavily in the development of its holdings in the Eagle Ford Shale, Granite Wash and Mississippi Lime.

Most importantly, the company’s efforts seem to produce desirable results, reflected by an almost 69% year-over-year increase in average daily oil production during the fourth quarter. It expects its natural gas production to decline by approximately 7% in 2013, while liquids production is expected to increase approximately 27%.

Chesapeake − the second-largest producer of natural gas in the U.S. after ExxonMobil Corporation (XOM - Analyst Report) − also remains proactive in reducing its long-term debt through monetizing its assets and cutting lease-hold spending. This monetization initiative is mainly aimed at reining in debt as well as filling the funding gap for its 2013 expenditures. Expenses mounted in the wake of continued low natural gas prices. The mid point of the operating cash flow guidance was increased by 5% to $4.85–$5.15 billion from $4.25–$5.25 billion.

Chesapeake plans to sell a 50% share of its 850,000 leasehold acres spreading over the Mississippi Lime play in northern Oklahoma to China Petroleum & Chemical Corp/Sinopec (SNP - Analyst Report). The all-in-cash transaction is valued at $1.02 billion, which disappointed most analysts’ expectations.

The total transaction price equates to only $2,400 an acre, which is much less than Chesapeake’s valuation of 7,000 to $8,000 for the asset in a July 2012 presentation. Hence, this divestiture deal pulled down Chesapeake’s shares by 6.8% to $19.11 in a day in the New York Stock Exchange on Feb 25, the largest daily decline since Nov 2.

Though the company’s ongoing asset monetization initiatives are working well, the company’s balance sheet is still more leveraged than its peers. At the end of the fourth quarter, the debt balance stood at $12.2 billion, representing a debt-to-capitalization ratio of 40.5%.

Again, since natural gas accounted for about 77% of Chesapeake’s fourth quarter production, results are particularly vulnerable to fluctuations in the natural gas market.

Over the last 30 days, we witnessed no earnings momentum for the stock for the first quarter of 2013. The Zacks Consensus Estimate is currently pegged at 21 cents per share, reflecting a year-over-year increase of 17.4%.

Other Stocks to Consider

Chesapeake stock currently retains a Zacks Rank #3, which is equivalent to a short-term Hold rating. However, there are companies like Range Resources Corporation (RRC - Analyst Report) that offer value and are worth buying now. The company carries a Zacks Rank #1 (Strong Buy).

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