Why SandRidge Is a Great Buy Right Now
Jul 23rd 2012 3:20PM
Updated Jul 23rd 2012 4:22PM
SandRidge Energy (NYS: SD) is a relatively young company with not much operating history. But in a short period of time, it's made some really smart moves that have created tremendous value for the company and its shareholders. This is definitely one oil and gas producer that should be on every energy investor's radar.
From natural gas to oil
As CEO Tom Ward recounts, SandRidge was originally a natural gas-focused company. But it has come a long way since its inception in 2006. As early as 2008, management saw the shifting tide and determined a period of low natural gas prices was on the way -- a remarkably prescient call in hindsight. So later that year, the company hedged all of its natural gas production for two years and began laying the foundations for a switch to oil.
At a time when other companies were still searching for natural gas properties, SandRidge acquired assets in the Permian Basin, an oil-rich play in western Texas. It made two acquisitions in 2009 and in 2010 for a total of $2 billion. The company then sold off a portion of those assets so it could fund its future projects in the Mississippian Lime, the most important part of the SandRidge growth story.
Banking on the Mississippian Lime
You can't talk about SandRidge without discussing the company's presence in the Mississippian Lime. Unlike other small-cap producers such as Kodiak Oil & Gas (NYS: KOG) , which are focused on unconventional plays like the Bakken shale, SandRidge is banking on lower-risk, conventional assets. The company is mainly concentrated on the up-and-coming Mississippian Lime play, a shallow and expansive carbonate oil play spanning parts of Oklahoma and Kansas.
While Chesapeake Energy (NYS: CHK) is the biggest leasehold owner in the Mississippian, with around 2 million net acres, SandRidge isn't too far behind, with a 1.5 million net acreage position. Devon Energy (NYS: DVN) is next in line, holding 230,000 acres in the expansive play.
SandRidge has reported 7,000 potential net drilling locations in the Mississippian and expects the average well to cost about $3.2 million, significantly cheaper than Bakken or Eagle Ford wells. The expected internal rate of return for Mississippian wells is 91% and some 380 horizontal wells are planned for 2012.
An aggressive, yet feasible, three-year plan
SandRidge expects to triple EBITDA and double oil production in three years. Ward elaborates: "We have a three-year strategy that no other company in the U.S. has, and that's that we're going to triple EBITDA, we're going to double our oil production, and we'll spend within our cash flow by the end of 2014; and all the while, we'll be improving our credit metrics."
Before you roll your eyes in disbelief, taking a look at the numbers might change your opinion. The company has some very attractive assets in the aforementioned Mississippian formation and the Permian Basin, which it acquired on the cheap. Between these two plays, it has close to 15,000 drilling locations and has been growing oil production at a rapid pace. In fact, production in the Mississippian set a record for SandRidge at 21,334 barrels of oil equivalent per day in late February.
Risks to consider and final thoughts
Despite the above reasons to be bullish on this company, there are a few risks investors should bear in mind. SandRidge carries a heavy debt load, with an alarmingly high debt-to-EBITDA ratio. To meet its aggressive growth targets, the company is massively outspending cash flow. In fact, its capital expenditures consistently exceed available cash and liquidity, leaving it heavily dependent on outside sources of capital.
While I do think SandRidge can close this funding gap eventually, Mr. Market is not so sure and is pricing in quite a bit of uncertainty with the stock trading toward the lower end of its 52-week range. Also, because the company is so highly leveraged, there's not much room for error. If oil prices fall further, the stock could get hit hard. Of course, management is well aware of this and continues to hedge aggressively. So even if oil falls further, they've got 80% of their production hedged for the year.
Despite these concerns, I still like this company and think it's a great, albeit risky, buy for investors with at least a three-year time horizon. Moreover, at its current price just north of $6, I think you're getting a whole lot more than what you're paying for. Its enterprise value is less than half (even more by some estimates) of the resources it's got sitting in the ground, waiting to be extracted. If the company can continue growing oil production at the fast clip it's become accustomed to, while keeping costs down, I think it's got a good chance of achieving its three-year plan.
While the biggest downside risk for SandRidge and other oil companies is falling oil prices, some energy companies are much more resilient to changes in the price of oil. In fact, one little-known oil and gas equipment provider has found a way to profit despite price fluctuations. Read more about this energy stock ready to soar in The Motley Fool's special free report: "The Only Energy Stock You'll Ever Need." Don't miss out on this limited-time opportunity to discover the name of this under-the-radar company. Click here to access your report -- it's totally free.
At the time this
article was published Fool contributor Arjun Sreekumar does not own shares of any companies listed above. The Motley Fool owns shares of Devon Energy and Chesapeake Energy. Motley Fool newsletter services have recommended buying shares of Devon Energy. The Motley Fool has a disclosure policy.
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