SandRidge Energy (SD) was reaffirmed with an equal weight rating by Barclays Capital earlier this month, showing that although lowered natural gas and crude prices are hammering exploration and production companies, some are still holding their own. I believe SandRidge is one of the more forward-looking names of the bunch, with an oil-weighted reserve base and growth-oriented production plans. While there are some areas of concern, such as SandRidge CEO Tom Ward's questionable past with Chesapeake Energy (CHK) CEO Aubrey McClendon and a debt-to-equity ratio that would be staggering for any company but a younger firm, overall SandRidge looks like a value proposition.
CEO Ward Can't Get Enough Distance From McClendon and the Chesapeake Disaster
As many are aware, Ward was co-founder of Chesapeake, which he led before departing to head SandRidge in 2006. Many of McClendon's woes now receiving an airing in the media tie back to Ward; both were involved in the Founders' Well Participation Program, both were running a hedge fund on Chesapeake company time, and both are self-admitted wildcatters. Although they are now at different companies, Ward and McClendon now have another thing in common: outrageous corporate perks revealed during proxy season.
Ward spent $783,533 of SandRidge's capital on "accounting support" from SandRidge's own employees. McClendon was reimbursed for the same spending by Chesapeake to the tune of $250,000. McClendon also ran up $1.1 million in airfare, though after "consultation between Mr. McClendon and the Compensation Committee" according to the company's proxy, McClendon reimbursed Chesapeake $650,000. Charging the company in the first place was a bad move for McClendon, already in imminent danger of losing his position at the top of Chesapeake.
Also in the questionable spending category, it appears SandRidge purchased naming rights for the Oklahoma City SandRidge Energy Stars & Stripes River Festival, held earlier this month to celebrate Independence Day. Although likely less of an expense than Chesapeake's multiyear, multimillion-dollar naming agreement for the former Oklahoma City Arena, now the Chesapeake Energy Arena, there are probably areas where energy companies' hard-earned cash could be better spent.
Given that SandRidge is performing considerably better than Chesapeake, one might think that Ward had room to negotiate such perks, but I think the key here is that Ward needs to remember as his relationship with McClendon and their decisions together are scrutinized, the scrutiny is bound to carry over to the present. In an unstable energy environment, Ward should be doing everything he can to reassure investors and spend wisely, which means cutting back on the perks.
SandRidge and Chesapeake are moving on many of the same plays as well, including the Mississippian Lime formation across Kansas and Oklahoma. The Kansas Department of Commerce expects that the two companies together will create thousands of jobs in Kansas over the coming decades, after analyzing data including the reduction in the unemployment rate that labor-intensive hydraulic fracturing brought to North Dakota. Kansas is doing all that it can to encourage producers; Kansas Department of Revenue secretary Nick Jordan said last year that Kansas "wants to make sure we handle it right in all areas, whether it be permitting or the cost of doing business here."
Poised to Grow on the Mississippian Lime
SandRidge currently has nearly 16 years of reserves at its current production level of 104 mboe/d, though it is quickly scaling up its production with aggressive drilling. The company hopes to achieve 54% oil growth this year, which would double its production from 2011 levels. With $1.5 billion in liquidity, SandRidge must use additional debt to take on this growth, though it still plans to be fully funded through cash flow by the end of 2014. Based on its current predictions, SandRidge will be using its funds to develop the acreage it already has, particularly in the Mississippian Lime.
The Mississippian Lime, which SandRidge refers to as its Mississippian Project, is one of SandRidge's strongest plays. The company has 1.7 million net acres on the play representing 8,000 net potential locations, from which it expects to produce 300-500 mboe per well. That might seem low, but SandRidge's cost per well averages only $3.2 million, which includes infrastructure build spending. This is one reason SandRidge is building out to 380 horizontal wells on this play alone. If that weren't a bullish enough indicator, consider that as of mid-June, SandRidge had 340 horizontal wells, compared to an industry total of 410, 208 of which belong to Chesapeake.
Devon Energy (DVN) is showing a more active interest in the Mississippian Lime as well. Though it only has six wells drilled on the play, it has two active rigs. It's also notable that Devon only released its first test well results on its first quarter 2012 conference call, and that first well had an initial production rate of 590 boe per day, better than SandRidge's average. It might be only luck, but Devon is encouraged enough that it plans to drill up to 50 more wells here this year, including test wells on other formations. Royal Dutch Shell (RDS.A), perhaps prompted by Exxon Mobil's (XOM) leading natural gas position in U.S. shale plays, is also catching up. With eight wells drilled Shell has four active rigs in play on the Mississippian, more than any other single driller aside from Chesapeake and SandRidge.
SandRidge is currently trading around $6 a share, which gives it a price to book of 2.0 and a forward price to earnings of 13.0. Though it recently broke above its moving average around $6.48, it appears headed back down to its support around $5.90, which is an excellent buy opportunity.
One of SandRidge's directors, Daniel Jordan, certainly believes that SandRidge is on its way up. Over the past six months, Jordan invested a total of $779,000 in SandRidge stock, which works out to an average cost of $7.79 per share. Though its debt to equity ratio is very high, at 1.9, it should be remembered SandRidge only debuted as a public company four years ago, and is more than capable of delivering double-digit growth in return for the debt load. Its plans to pay down that debt load and fund out of revenues are also a bright spot, and an indicator that SandRidge will be in a position to pay a dividend in the long term.
SandRidge will release second-quarter results after the closing bell on Aug. 2.