Chesapeake Energy Yields Between 11% and 13% - Much Higher Than It Appears

• Chesapeake Energy (CHK) pays a two-layered dividend and has a much higher dividend than most pricing services are aware of
• The oil and gas company pays out a base dividend of $1.75 (2.21% yield), plus a variable dividend based on 50% of adj. free cash flow
• Moreover, Chesapeake recently said its base dividend will now increase to 50 cents quarterly or $2.00 annually, giving a CHK stock a base yield of 2.50%
• The variable dividend could be as high as $8.43 this year (10.6% yield), giving it a combined yield of 13.0%, using the CHK's estimates of its cash flow
• If oil prices fall 20%, the variable yield would fall to 8.5%, but the combined yield would still be 11.0% including the 2.5% base dividend.

Chesapeake Energy pays a much higher dividend than it may appear, especially if you look at all the major pricing services. Most of these say that CHK stock has a yield of around 3.66% or lower.

But the reality is that Chesapeake Energy pays out much more. As a result, investors in CHK should realize that the stock now realistically yields between 11% and 13%.

This should help push up CHK stock as the market begins to understand the new complicated dividend structure.

The New Dividend Structure

 On Feb. 23 the oil and gas company explained its first quarterly dividend structure in its Q4 earnings release. It declared a base dividend of 43.75 cents and a variable dividend of $1.33, as explained on page 2 of that release.

The base dividend works out to an annual dividend rate of $1.75. However, in that same release, Chesapeake said it would raise the base dividend to 50 cents in the next payment in June 2022. So the annual base dividend yield is about 2.50% (i.e. $2.00 / $79.94).

In addition, the variable dividend, is 50% of the quarterly adjusted free cash flow (FCF), after deducting the base dividend, and adjusting for cash paid for acquisitions (after deducting capex). That worked out to $372 million last quarter. 

After deducing $52 million in base dividend payments, and taking 50% of this number, the variable quarterly dividend was $160 million. Now since there are 120 million shares outstanding the variable dividend worked out to $1.33 per share.

Where This Leaves the Dividend Going Forward

Theoretically, we could just annualize these payments, assuming that everything stays the same (i.e., oil and gas prices and FCF) for the rest of the year. That implies that the full-year base dividend would be $2.00 and the annual variable dividend would be $5.32 (i.e., $1.33 x 4).

Therefore, the annual dividend might be estimated as $7.32 per share, which works out to a dividend yield of 9.15% (i.e., $7.32/$79.94).

However, we can do better than that. The reason is Chesapeake was kind enough to provide an annual estimate of their cash flow. Their one-page Outlook statement shows that EBITDAX will be between $3.8 and $4.0 billion. EBITDAX is not free cash flow and we have to make some adjustments. 

For example, after deducting its own estimate of capital expenditures, the EBITDAX number falls to $2.2 to $2.3 billion. In addition, after deducting $115m in taxes and $125m in interest, as well as $1.5 billion in capex, the best estimate is for $2 billion in FCF. Taking 50% of that results in $1 billion in distributable FCF. Across less than120 million shares that results in a variable dividend of $8.43, or a variable yield of 10.5%. 

That gives a combined yield of 13.0% (i.e., 10.5% variable and 2.5% base). That is a lot higher than the straight-line assumption of a 9.15% yield.

Even if oil prices were to fall by 20%, the variable yield would still be 8.4% and the combined yield would be 10.9% or about 11%.

What To Do With CHK Stock

If you were able to follow all these numbers, good for you. Suffice it to say that the pricing services are all mispricing the company's complicated and structured dividend. The stock is likely to move significantly higher as a result, when the market realizes this.

Mark R. Hake, CFA

Scottsdale, AZ