How early is too early after a huge rally to all-time highs in U.S. stocks?
Buying too early is always a worry, of course, but a market rally like this forces investors or traders seeking bargains to look further and further out. A stock like Citigroup (C) that I'd argue is still in the very beginning of a recovery is up 99.9% in the last 12 months. And a stock where you can actually see a recovery in action? Forget about it. A homebuilder such as Pulte Group (PHM) is up 134.9% in the last 12 months.
So how far out are you willing to look for a bargain?
At the moment, Chesapeake Energy (CHK) marks the bargain frontier for me.
The company is still struggling with low natural gas prices that have started to recover (maybe) but that are still well below the cost of production for many companies in the industry. And the company, which loaded up on debt to acquire drilling leases, is still looking to sell assets to fill a funding gap of about $3.5 billion in 2013. Asset sales, uncomfortably, have been going more slowly than the company projected at the beginning of the year.
But I see five major catalysts that make me willing to buy Chesapeake Energy now while the price is relatively low because the problems at the company and in the market are so visible.
First, it looks like natural gas production in the U.S. will grow by just 1% in 2013, according to the U.S. Energy Information Administration. That's a big drop from the 8% growth of 2011 and the 4% growth in 2012.
Second, that decline in production growth, plus growth in demand for natural gas, looks like it will push natural gas prices higher in 2013. Standard & Poor's is projecting Henry Hub spot prices will average $3.72 per million BTUs (British Thermal Units) in 2013, up from just $2.58 in 2012. In 2014, S&P projects, prices will average $5.00 per million BTUs.
Third, Chesapeake's production is showing an increasing shift toward oil and natural gas liquids that command higher prices than natural gas. Liquids will make up 26% of production in 2013, the company projects, up from 24% in 2012. Liquids production is projected to climb by 28% in 2013.
Fourth, Chesapeake has shifted away from its traditional strategy of land acquisition and asset sales to a more conventional emphasis on drilling and production. In 2013 spending on land acquisition will drop to just $400 million out of a $6 billion capital spending budget. The rest of that budget in 2013 will go to spending on drilling for development and production. That's a huge shift for a company that spent $5.8 billion on acquiring leases in 2010.
Fifth, long-term CEO Aubrey McClendon retired in April and has been replaced by Doug Lawler from Anadarko Petroleum (APC). McClendon built Chesapeake but his strategy of aggressively growing acreage under lease has seemed increasingly out of touch with the current natural gas market. And a series of extremely questionable decisions about McClendon's compensation -- a $75 million incentive package in 2008 that seemed completely detached from performance, for example -- had badly tarnished Chesapeake.
Lawler comes to Chesapeake having most recently headed Anadarko's international and deepwater operations including the company's LNG project in Mozambique. Before that he headed Anadarko's unconventional onshore development. To me this sounds like good match of CEO and company strategy.
The shares are up 33.3% in the last 12 months, but considering the company's near death plunge from $62.90 on June 26, 2008 to $14.25 on Dec. 2, 2008, the current price of $22.45 leaves plenty of headroom. I calculate a $31 a share 12-month target price.