During a period in which the market has driven the valuations of some of the world's largest energy companies down to near bargain levels, it is easy to wonder why anyone would consider a smaller, growth play. While this makes sense in the most general sense, SandRidge Energy (NYSE:SD) is an exception. Despite a market capitalization of just $3 billion, a mere afterthought when compared to BP (NYSE:BP) at $138 billion, ConocoPhillips (NYSE:COP) at $92 billion, Chevron (NYSE:CVX) at $210 billion and Exxon Mobil (NYSE:XOM) at $406 billion, SandRidge has nice diversification between oil and natural gas, focused primarily in the exploration segment. While it is hard to pass on some of the majors at current valuations, SandRidge is certainly a smaller player worth considering.
Before addressing some of the many reasons that SandRidge is an attractive candidate at current levels, the valuation discussion begun above should be fully addressed. Using the trailing twelve month price-to-earnings (P/E) ratio as the primary metric, the company can be put into context among its peers. SandRidge has a P/E of 58 relative to a P/E of 7.9 for ConocoPhillips, a P/E of 5.4 for BP, a P/E of 7.9 for Chevron and a P/E of 10.2 for Exxon Mobil. With an industry average of 10.5, it demonstrates that the majors are relatively cheap at current levels, and SandRidge is fairly expensive.
When growth is added, however, the story changes and SandRidge stacks up more favorably. Using the price-to-earnings over growth (NYSE:PEG) ratio, SandRidge has a PEG of 0.17 relative to 1.3 for ConocoPhillips, 1.29 for BP, 1.48 for Chevron and 1.5 for Exxon Mobil. In general, a PEG below 1.0 is considered favorable because it means that the valuation - measured by P/E - for every percent of growth is relatively cheap. The preceding explanation notwithstanding, comparing the PEG of a $3 billion market capitalization stock to the major is not appropriate as an apples-to-apples comparison. What it does highlight is that there are multiple ways to think about valuation and on a growth basis, SandRidge is very attractive. With a PEG below 0.2, an investor is paying very little in terms of valuation for significant amounts of expected growth.
Another important metric to consider is operating margin. It provides a quick snapshot of how efficiently the company is operating and how sound the decisions of management have been when executed. SandRidge has an operating margin of 30.4% relative to 9.7% for ConocoPhillips, 8.3% for BP, 16.2% for Chevron and 12.5% for Exxon Mobil. While it would be outstanding to see any of the majors even close to the efficiency of SandRidge, the realities of organizations that big is that growth often comes at the expense of pure efficiency. The nimble choices available to smaller companies are not possible beyond a certain size. Similar projects are accepted, but the impact on the bottom line is muted. The message again is that SandRidge is an extremely well-run organization.
The Expectation of Growth
While all companies wish, and in a sense expect, to grow, making a careful analysis of this prospect is important when considering an investment. The company is expected to make comments this week that have the potential to act as a catalyst and move the stock. Through a recent acquisition of Dynamic Offshore Resources, the company has shown its clear intention to grow. The acquisition was financed largely through the offering of $750 of senior notes, which represents a significant addition to the company's overall debt profile.
The comments that are expected will address this debt structure and should quell some of the concerns that may have arisen as a result of the move. The function of the acquisition is twofold: to expand the company's operations in the Gulf of Mexico in shallow oil leases and wells and to add more proven resources to the company's balance sheet. Each of these factors can be expected to be positive for the company. When put into the context of SandRidge's diversified oil and natural gas strategy, the expanded reach should aid some of the growth that the company needs to stay competitive.
One issue that should be considered is the potential future of fracking procedures. Much like Chesapeake Energy (NYSE:CHK), the company engages in fracking on the natural gas side of its business. The process is used to extract natural gas from otherwise undrillable areas. Recent scientific studies have suggested that there may be a significant ecological cost to the process. This, in turn, brings into question how government regulators will react and what limitations, if any, will be placed on the practice. The fact that SandRidge is not as dependent on the process as others like Chesapeake is a real positive for the stock, but anyone investing in the stock should be aware of this potential controversy as it could impact the future growth.
A final important factor to consider surrounding SandRidge is that at such a relatively low market capitalization, the company is an attractive takeover candidate. This has multiple benefits to shareholders. First, when a company is acquired, the purchase price is usually at a premium to the shares' market price. This means that even the rumor of a bona fide purchase offer could send the stock higher. The second consideration is that if the company does not wish to be acquired, it is doubly motivated to grow because the higher the market cap, the harder an acquisition. These additional factors add to the attractiveness of the stock at current levels.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.