UPDATE: Chesapeake Energy (CHK) Seen as Expensive, Too Highly Leveraged; UBS Downgrades to Sell

(Updated - June 25, 2015 8:55 AM EDT)

UBS downgraded Chesapeake Energy (NYSE: CHK) from Neutral to Sell with a price target of $11 (from $16). Analyst William A. Featherston is cautious on the company's high leverage, combined with declining production, and he sees the stock as expensive compare to peers.

"Following the reduction in our normalized US natural gas price to $4.00/MMBtu, we are reducing our rating on CHK from Neutral to Sell. In addition to our lower gas price forecast (gas represents 73% of 2015E production), we think CHK carries far too much financial leverage, prompting a material reduction in activity that is contributing to a declining production profile in 2015-16E. While CHK is just one of two companies in our universe with both declining production throughout 2015 and into 2016 and a deteriorating balance sheet (FCF negative), it trades at a material premium to peers on EV/DACF," said Featherston.

The analyst continued, "As favorable hedges expire that are contributing to over $1 billion in 2015E revenue, we expect CHK's modest 2016E hedge position will leave it with a net debt/2016E EBITDX ratio of >5x . . . well above the peers avg of 2.3x and CHK's <4x debt/EBITDX covenant (we assume that could be relaxed). And while CHK has liquidity of $6.9 billion (including $2.9 billion of cash on hand), we forecast organic FCF deficits of $1.6 billion and $1.3 billion in 2015-16, respectively, despite the material reduction in drilling activity."

Commenting on the Chesapeake's declining production, Featherston said, "CHK's production has already begun to decline in 2Q, and should see accelerated declines as well completions fall from >250 in 1Q to ~180 in 2Q and just ~50 in 4Q. We forecast 2016E production declines 5% YoY to 617 MBoed, below consensus of 625 MBoed. And given the FCF deficit, we forecast CHK has below average production and cash flow per debt-adjusted share growth compared to its peers in 2015-19E."

For an analyst ratings summary and ratings history on Chesapeake Energy click here. For more ratings news on Chesapeake Energy click here.

Shares of Chesapeake Energy closed at $11.55 yesterday.

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