How A Decline In The Demand For Natural Gas Would Impact Our Fair Price Estimate For Chesapeake
Natural gas as a commodity has been increasingly used as a substitute for coal for power generation given its comparative environmental and cost advantage. This has helped expand the demand for the commodity, supporting its prices. However, with a greater regulatory push for a cleaner environment, utility companies are now replacing their natural gas plants with solar and wind energy plants. This could have a severe impact on the demand for natural gas in the upcoming years and thus impact our valuation of Chesapeake.
Our base case valuation model for Chesapeake has a fair price estimate of $4.31 for the company based on an EBITDA estimate of $2.6 billion for the year ending December ’18. However, a fall in demand for natural gas would lead to a revised EBITDA estimate of $2.5 billion. With an estimated share count of 906 million and P/EBITDA unchanged at 1.5, we arrive at a new fair price estimate of $4.15 for the company. This price is 4% lower than our base case estimate.
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A decline in EBITDA of ~100 million is a direct impact of a fall in total revenue of the company. Our total revenue in the base case assumption of $9.7 billion is comprised of revenue from the company’s crude oil segment of $2.1 billion, natural gas segment of $2.5 billion, and natural gas liquids (NGLs) segment of $494 million. Additionally, the marketing, gathering & compression division is expected to contribute a revenue of $4.6 billion to the total figure. A decline in revenue to $9.4 billion is due to a change in our revenue estimate of the company’s natural gas segment. Volume sales from the natural gas segment is reduced by 7% from our base case assumption of 2454 mmcd/ day to 2286 mmcd/day and average price per mcd is reduced by 8% from $2.84 / mcd to $2.62/ mcd. This leads us to a revised revenue estimate of $2.2 billion from the company’s natural gas division, ~14% lower than our base case scenario. The lower price and volume estimate is in the backdrop of lower natural gas demand, highlighted previously. Advancement in technology has made solar & wind power extremely attractive to utility companies in the U.S., which previously was an obstacle. Hence, an increased substitution would likely lead to a fall in the demand for natural gas and consequently have a negative impact on its prices. We expect this substitution to occur gradually and hence have a material impact on the company’s stock price over the years.
Thus, we arrive at our new price estimate for the company of $4.15, given if such a scenario does occur. Although the company itself has refrained from further investment in its natural gas segment due to the unattractive opportunities present for the commodity, the natural gas division does have a material contribution to the company’s valuation and hence a fall in revenue from this segment would have a negative impact on its stock price.
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