I discussed the possibility of a reverse split coming for shares of Chesapeake Energy (CHK) back in November. At that time, management had just issued a going concern warning, and shares had recently fallen below the key $1.00 a share level. While the company has made an important debt move to improve the financial future of the name, the stock’s recent action combined with depressed natural gas prices lead me to believe a reverse split is now just a matter of time.
Dropping below a dollar per share at the beginning of November wasn’t necessarily a death knell for the stock in the short term. However, trading below this critical level has continued for an extended period of time. It was back in early December that the company detailed the following piece in a filing with the SEC:
The average closing price of our common stock, $0.01 par value per share (the “Common Stock”), over the 30 consecutive trading day period beginning October 21, 2019 and ending December 2, 2019 was below $1.00 per share, which is the minimum average closing price per share required to maintain listing on the New York Stock Exchange (the “NYSE”) under Section 802.01C of the NYSE Listed Company Manual.
Chesapeake will have a period of six months following the receipt from the NYSE of the notice of non-compliance to regain compliance with the minimum share price requirement, with the possibility of extension at the discretion of the NYSE. If, after receipt of the notice, Chesapeake fails to regain compliance with Section 802.01C of the NYSE Listed Company Manual by the end of the cure period, the Common Stock will be subject to the NYSE’s suspension and delisting procedures.
Chesapeake shares aren’t even fetching 70 cents at the moment, and they couldn’t even get above a dollar during a December rally. The recent oil price rally on US/Iran tensions helped for a time, but crude has come back down and so has Chesapeake. The chart below shows the stock’s 30-day average closing price since shares first crossed that critical $1.00 level.
(Data sourced from Yahoo! Finance – last data point on the chart is for close on January 17, 2020)
Assuming that Chesapeake got the NYSE notice in early December, it means that we are more than a quarter of the way through the six-month period. When the company’s Q4 earnings report comes on February 26th, we’ll be less than a week away from the halfway point. With the 30-day closing average possibly falling below 80 cents again this week, it’s going to take a lot to get the line back above $1.00.
The biggest problem for Chesapeake now is that natural gas prices continue to fall, falling below $2.00 at one point last week as seen in the chart below. In the company’s 2019 third quarter 10-Q filing, the company showed average natural gas production of a little more than 2 billion cubic feet per day for the nine-month period to date. That averages out to about 730 billion cubic feet per year, but for 2020, the company ended October 2019 with only about 370 billion cubic feet hedged according to the most recent earnings presentation.
At the Q3 2019 earnings report, management said it believed it could produce some free cash flow this year based on its current forecast. The day before that earnings release, natural gas closed above $2.82, meaning it has dropped nearly 29% since. Unless the company was able to put on a large amount of hedges in a short time, that free cash flow picture seems a lot more difficult to achieve. As a point of reference, natural gas prices only closed above $2.50 for about four weeks in Q4 2019, with one of those weeks leading up to the above-mentioned earnings report.
The reason I think a reverse split is inevitable is simple logic. Even if shares are able to get over the $1.00 level in the next few months, what’s to say they won’t drop back below that later this year? Then, the company would get another NYSE notice, and we’d be back in the same situation we are now. Doing a reverse split now, to get the share price back to $5, $10, or whatever the board feels is necessary would remove this overhang that seems to be with the stock right now.
With natural gas prices testing the $2.00 mark, shares of Chesapeake Energy remain well below the $1.00 level needed to remain trading on the NYSE. At this point, with a good chunk of this year’s gas production unhedged, it seems like positive free cash flow may not happen. With Q4 earnings not until late February and the Middle East situation having calmed down, it doesn’t seem like investors are going to bid this stock up significantly in the near term. As a result, it seems inevitable that a reverse split is going to happen, so I think the company should just get it over with now.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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