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Thesis

Sandridge Energy (NYSE:SD) remains one of my top undervalued energy picks for the next couple of years. Regular readers of my articles understand that the strategy I follow for my investments is contrarian in nature. I believe that misunderstood investments are often mispriced investments. Group-thinking and changes in sentiment offer outsized upside potential when rationality returns to the market. A few examples of recent fundamental mispricings include U.S. healthcare companies that were priced for disaster in 2010 because of Obama's healthcare law, mortgage insurance companies Radian (NYSE:RDN) and MGIC (NYSE:MTG) as well as Greek banks able to pursue capital raises and, of course, American International Group (NYSE:AIG).

I have previously written that it has turned well for my overall investing strategy to specifically look at the sector underdog, companies that the majority of investors have given up on. Apache Corporation (NYSE:APA) and BP (NYSE:BP) are such undervalued companies in the exploration sector (contrarian thesis worth a read: here and here) while Bank of America (NYSE:BAC) was a great value investment in 2011 (it still is). Sandridge Energy's performance over the last year classifies the company as an underperformer. Apache, Occidental Petroleum (NYSE:OXY) and Anadarko Petroleum (NYSE:APC) pressed ahead while Sandridge Energy continued to restructure its business.


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Background

Sandridge operates an oil- and gas business with a substantial focus on the Mississippian region. Management focused on de-risking the business, improving liquidity, divesting its Permian assets and optimize capital spending: Sandridge is emerging as a more focused, leaner organization committed to building its Mississippi leasehold position and continues to make substantial progress in increasing production levels for its core operations.

Progress in transitioning business model

Sandridge focuses its operational efforts on increasing oil- and gas production from its Mississippian operations. Reconciling 2012 actual production figures with management's 2013 production guidance suggests that oil exploration is set to increase 76% and gas production is expected to increase 66% y-o-y. An overview of Sandridge Energy's average quarterly production growth for its Mississippian operations is provided below:


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De-risking business strategy successful

Sandridge Energy's sustained focus on increasing operational efficiencies, divesting assets and restructuring its balance sheet has improved a variety of leverage metrics: Since Q4 2012 total debt is down 26% from $4,301 million to $3,195 million in Q2 2013. The leverage ratio is down from 3.4x in Q4 2012 to 2.4x in Q2 2013 and Sandridge's liquidity position has improved nearly 75% with liquidity in Q2 2013 standing at $1,841 million. Proof that a focus on de-risking the oil- and gas portfolio and capital structure produced tangible results for shareholders.


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Outlook

In Q2 2013 Sandridge continued to improve its Mississippian well cost leadership position at an average of $2.95 million. Mississippi production rose an impressive 20%. Sandridge Energy remains focused on developing its Mississippian core oil- and gas assets and continues to have a tight grip on productive capex.

Leon Cooperman is on your side and sees 100% upside

Renowned value investor Leon Cooperman also endorsed Sandridge Energy as an investment. During CNBC's Institutional Investor Delivering Alpha conference the founder of hedge fund firm Omega Advisors suggested about 100% upside potential for Sandridge as the market misunderstands its operational strength and capex discipline. Forbes reported:

The billionaire said the oil and gas stock could double from its current $5 level - he also acknowledged it could go bankrupt if things broke really wrong - largely because it is getting virtually zero credit for its capacity to develop acreage and reduce spending. Net asset value is double where the stock trades, Cooperman figures.

Since Cooperman's presentation the shares are up 20% but still have another 67% to go to hit Cooperman's lose price target.

Leon Cooperman is a great value investor with an impressive track record and annual, after-fee returns of 14.3% since 1992. If you look at his portfolio holdings you will find stocks that the majority of investors would not be comfortable to hold: Spin-offs and restructuring plays such as Motorola Solutions (NYSE:MSI), LyondellBasell Industries (NYSE:LYB), Citigroup (NYSE:C) and, well, Sandridge Energy.

Conclusion

Sandridge Energy's stock price has been driven down because of a transitioning business model which now focuses on its Mississippian oil- and gas portfolio. The company is streamlining its operations and has divested its non-core Permian assets. At the same time Sandridge restructures its balance sheet with substantial improvements: Sandridge's net debt position was cut in half in just the last two quarters. Current executions of development plans and increases in Mississippi oil- and gas production confirm that the move to strengthen its Mississippi operations was the right move for shareholders. Further production increases and EPS surprises are likely to be determining catalysts for Sandridge Energy in the future. Contrarian investors also benefit by having renowned value investor Leon Cooperman on their side who sees another 67% upside potential. A long-term Buy.

Source: Sandridge Energy: A Contrarian Oil And Gas Bet With Significant Upside Potential