Fitch: Chesapeake CDS Tread Wider; Mirror McClendon Exit Levels

NEW YORK--(BUSINESS WIRE)-- Five-year credit default swaps (CDS) for Chesapeake Energy Corporation (BB/Stable) have widened 29% over the past month and 11% over the last week, according to Fitch Solutions. The spreads are up 223% since reaching recent lows in late August 2014. Notably, CDS spreads are at levels not seen since late January 2013 when the company's outspoken co-founder, Aubrey McClendon, stepped down as CEO.

Chesapeake's CDS spreads have likely widened due to renewed concerns regarding its levered capital structure, continued exposure to legacy obligations, and the impact that weaker natural gas prices will have on its ability to de-lever. Fitch Ratings recognizes, however, that the company has made considerable progress since 2013 to simplify its capital structure, as well as improve its liquidity profile. Further, Fitch believes Chesapeake's realized prices could exhibit positive trends with Marcellus basis differentials steadily improving over the medium term and, possibly, the formation of Barnett and Haynesville partnerships as well as constructive discussions with its midstream partner.

Management is in the process of ramping down drilling activity to help preserve financial flexibility in 2015. Chesapeake expects to exit the year with 14 rigs operating at a quarterly capital spending rate of approximately $450 million, but at a cost of negatively affecting production rates going into 2016. In particular, liquids production is anticipated to come under heightened pressure given the considerable cutbacks allocated to the liquids-rich Eagle Ford. Fitch believes that the company's capital allocation decisions have been strongly influenced by its legacy obligations and anticipates that this will continue to limit its flexibility in reallocating capital in the downturn.

Fitch's base case projects that the company's cash flow metrics will widen considerably with balance sheet debt/EBITDA of over 5.4x in 2015 (compared to approximately 2.9x for the latest 12 months ended March 31, 2015) reflecting very weak oil and gas price realizations. Fitch's base case West Texas Intermediate (WTI) and Henry Hub price forecast assumptions of $60/barrel and $3.25/mcf in 2016, respectively, suggest that Chesapeake will need to continue to take a measured approach to capital spending with a heightened focus on capital efficiency. In Fitch's base case, we expect the company will continue to outspend operating cash flow in 2016, albeit at considerably lower levels, resulting in debt/EBITDA generally consistent with 2015 forecast levels. Fitch estimates that, in a $70/barrel WTI and $3.50/mcf Henry Hub price environment in 2017, balance sheet debt/EBITDA could decline to about 3.5x.

Legacy obligations of nearly $2.1 billion result in a Fitch-calculated exploration and production (E&P) adjusted debt/EBITDA of nearly 6.6x in 2015. While management has been attempting to reduce its exposure to these operational and financial obligations, Fitch anticipates they will remain a credit rating overhang given low hydrocarbon prices. The possible exit from CHK Cleveland-Tonkawa ($1.2 billion) would improve E&P adjusted debt/EBITDA to about 6.1x in 2015.

The company's liquidity is forecast to be adequate over the near term given the steps taken by management to reduce capital spending and the need for debt funding. Cash and equivalents were $2.9 billion as of March 31, 2015 with Fitch's base case forecast a year-end 2015 balance of approximately $1.9 billion. Another consideration is the considerable financial flexibility, relative to other high yield E&P companies, afforded by Chesapeake's size and scale. This is reflected in the proved reserve- and production-based credit metrics of approximately $5.35/boe and $19,300, respectively, as of March 31, 2015, which is generally consistent with some large, diversified investment-grade peers.

The current weak oil and gas pricing environment has limited Chesapeake's ability to further simplify its capital structure. Optimizing returns -- within the confines of its legacy obligations -- is likely to remain the company's focus. Fitch does not expect a negative rating action in the near term given the steps taken by management to preserve the company's current liquidity position, the company's considerable financial flexibility, and prospects for an improving oil and gas price environment. However, a large, leveraging transaction and/or an acceleration of drilling activity without supportive hedging/market prices could pressure the rating.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Source: Fitch Ratings

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