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NEW YORK (Dow Jones)--Amid a swarm of natural gas producers rushing to acquire acreage in hard-to-drill rock formations throughout the U.S., Chesapeake Energy Corp. (CHK) has stood apart as one of the most voracious land buyers.

In recent years, some investors and analysts have questioned whether Chesapeake's aggressive strategy exposed the company to too much risk. But if the company's second-quarter results are any indication, the acquisitive tactics are paying off - and the best may be yet to come. Analysts are generally bullish on its stock, which they consider undervalued and due to benefit from even greater gas production.

Oklahoma City-based Chesapeake has surpassed BP Plc (BP) and Anadarko Petroleum Corp. (APC) as the largest producer of U.S. natural gas, according to the companies' second-quarter production data. Chesapeake's average daily U.S. natural gas production in the second quarter was 2,328 million cubic feet, which was 9% more than BP's output and 25% greater than Anadarko's.

Anadarko and BP have lagged behind Chesapeake in acquiring acreage, particularly in the Haynesville Shale, a vast shale rock deposit in Louisiana and Texas that is expected to be a major source of natural gas. Smaller gas producers, including Petrohawk Energy Corp. (HK) and GMX Resources Inc. (GMXR), have also snapped up significant Haynesville holdings, but Chesapeake remains the top leaseholder in the shale deposit.

Chesapeake "is a great example of an aggressive, opportunistic corporate structure," said Jake Dollarhide, the chief executive of Longbow Asset Management, a Tulsa, Okla., investment firm. Longbow has about $40 million in assets under management and holds less than 200,000 shares in Chesapeake.

A 'Gold Mine'

Over the past seven years, Chesapeake's U.S. natural gas production has increased nearly sixfold.

After completing a flurry of acquisitions, including about 8,600 undeveloped acres in Texas' Barnett Shale in January, Chesapeake now owns substantial positions in key natural gas reservoirs, including the Haynesville Shale and the Marcellus Shale in Appalachia. Since early 1998, the company has spent about $18.4 billion to purchase reserves totaling about 7 trillion cubic feet of gas equivalent, or tcfe.

"Our ability to convert leasehold into annual increases of 2 to 2.5 tcfe of reserves is the foundation for our belief that Chesapeake can continue increasing value by at least $10 billion per year," assuming natural gas prices average about $8 a million British thermal units, Chesapeake Chief Executive Aubrey McClendon said in a statement announcing the company's second-quarter results earlier this month. The company didn't return calls for further comment.

Chesapeake has been a particularly active acquirer of land in the Haynesville play. Like other shale reservoirs, Haynesville requires more costly and technologically advanced drilling techniques to extract gas embedded deep in rock formations, but high natural gas prices have made such endeavors profitable.

According to the most optimistic estimates, Haynesville could produce up to 245 trillion cubic feet equivalent of natural gas, enough to supply the entire U.S. for a decade.

"Chesapeake is paying a lot per acre because they see the potential there," Dollarhide said. "It's an untapped gold mine."

In addition to buying up acreage at a rapid clip, Chesapeake has also been successful in attracting the personnel and equipment needed to drill the properties successfully, even as soaring demand for skilled oil and gas workers leads to labor shortages.

"It's incredible how high a level of activity they've been able to sustain," said Jason Gammel, an analyst with Macquarie Securities in New York.

Risky Business

Although Chesapeake's drilling efforts have been fruitful so far, the company's strategy isn't without risks. Chief among those risks is the volatility of natural gas prices, which have swung sharply between $8 and over $13 a million British thermal units in recent months. Natural gas for September delivery on the New York Mercantile Exchange settled floor trade at $8.406 a million British thermal units on Monday.

A sharp uptick in natural gas production from shale plays, or from liquefied natural gas imports to the U.S. from overseas, could send natural gas prices plummeting and cut into Chesapeake's profits.

"The natural gas backdrop right now is less than stable," said Dan McSpirit, an analyst with BMO Capital Markets in Denver, Colo.

And Chesapeake's drilling activity could become more costly as shale gas production ramps up and energy companies clamor for the same equipment and job candidates. Higher costs could lead the company to add more debt to its already highly-leveraged balance sheet.

As of June 30, Chesapeake had about $13 billion of long-term debt and $3.2 billion of assets on its books.

"It could be a challenge to maintain oilfield service and supply commitments and do it at reasonable pricing levels," Gammel said.

As for the company's shares, they have a forward-year price-earnings ratio of 11.7, compared with 9.5 for the industry. But analysts are basing their optimistic outlooks on Chesapeake's future earnings, when Haynesville has started producing. Analysts think the company is undervalued because the market has not fully taken into account the value of Chesapeake's shale acreage and the gas within.

In a recent note, Scott Hanold, an analyst with RBC Capital Markets in Austin, wrote that early results from test wells at Haynesville support a "bullish" view of Chesapeake's stock.

"We maintain our outperform rating because valuation looks attractive and we expect positive Haynesville results over the coming quarters," Hanold wrote.

Like all independent gas producers, Chesapeake's stock is heavily tied to changes in natural gas prices; recent share price swings have directly corresponded to volatility in natural gas prices. Chesapeake shares were recently trading around $46; they traded as high as $74 on July 2.

Although Chesapeake's heavy debt load creates some risk for investors, the company is expected to generate significant cash flow as production ramps up, analysts said.

At current price levels, Chesapeake's shares represent a compelling opportunity for investors, Gammel said.

"The stock is just exceedingly undervalued right now," he said.

(Christine Buurma covers U.S. power companies and the natural gas market for Dow Jones Newswires. She can be reached at 201-938-2061 or by email at [e-mail].)

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