SandRidge Energy, Inc. (SD) improved both its earnings and operating cash flow in the second quarter over the quarter a year ago, as also increased its net income available to common stockholders by an impressive 75%. This allowed it to report earnings of $0.07 per share for the second quarter of 2012 as compared to earnings of $0.00 per share in the second quarter of 2011. The second quarter 2012 earnings were far above the average analyst estimates, which predicted $0.01 earnings per share for SandRidge. The increases were driven largely by SandRidge's production on the Mississippian, where its production grew by 199% since the same period last year.
Less Dealing, More Drilling
With an average of 43 rigs operating, 33 of which are currently dedicated to the Mississippian play, SandRidge is maintaining its leadership position on the Mississippian, drilling nearly half of the 872 industry total horizontal wells drilled on the play to date. In the first six months of this year alone, SandRidge drilled 159 horizontals, and plans to exit the year with 380, giving it just six months to complete 221 drills and meet its goal.
Its plans for the Permian are even more aggressive; after drilling 206 wells in the second quarter, SandRidge plans to drill 544 further wells on the Permian by the year-end, using an average of 12 rigs. This drilling schedule reflects both SandRidge's position on its growth track, since it now holds the acreage it needs for this kind of drilling effort, and recent industry setbacks that are causing investors to question deals and balance sheets that seem overly complicated or worse, obscure. This is leading exploration and production players to focus on their core business, which is E&P - not land brokerage or derivatives trading.
SandRidge's CEO Tom Ward is also seen by some as tainted by his past history at Chesapeake Energy (CHK) and its CEO Aubrey McClendon, whose standing as a visionary CEO sank steadily in line with Chesapeake's stock price as the firm was rocked by scandal after scandal earlier this year. The willingness of other money managers to make publicly disparaging comments about McClendon shows just how far the slide really was; recently, Scott Carmack of Leader Capital Corp told Bloomberg that Chesapeake's note prices may never reach former values "just because investors will continue to wonder if there are any additional skeletons in the closet… I don't think, at least for us, that Aubrey McClendon has regained any trust," despite a board realignment and increased transparency since the June stockholder meeting.
Ward, predictably, is distancing himself from these scandals and former protégé McClendon, at least publicly. This is also benefiting SandRidge, since the firm is largely holding back from high profile opportunities to continue massive spending for growth, instead of focusing on developing held acreage. There were several opportunities for SandRidge to spend in the first half of this year, including the sale by Eagle Energy Production, a subsidiary of RiverStone Holdings, LLC, of substantially all of its position in the Mississippian Lime; Midstates Petroleum (MPO) will now take over the 37 mmboe in reserves offered in the deal.
SandRidge's plans to issue a senior debt offering is also an indication that SandRidge is taking a more circumspect approach to financing; the firm could just as easily choose to increase its credit revolver or enter into a volumetric production payment, as Chesapeake did multiple times when Ward was in the lead. Instead, SandRidge is expecting to issue nearly $1.5 billion in senior notes due between 2021 and 2013 to fund a tender offer of Senior Floating Rate Notes due in 2014, laddering its debt to pass through the current price environment.
Like EOG Resources (EOG), SandRidge's strong results allowed it to increase its 2012 production guidance; SandRidge raised its guidance to 33 mmboe from 32.3 mmboe, a 2% increase. EOG increased its total production guidance by 2% as well, though in EOG's case 2% of production is measured by millions of barrels. For SandRidge the increase is also coming at a substantial cost, since SandRidge raised its capital expenditure guidance to $2.1 billion from $1.85 billion at the same time; EOG's capital expenditure plans remain unchanged.
Although it has most of its oil production hedged over $100 a barrel, SandRidge can not purchase protection against its stock price in the same way it can protect itself against losses. Investors are leery of SandRidge for multiple reasons, not least of which is its size; at a market cap of just $3.2 billion, SandRidge is at increased risk for large slides in its stock price based on commodity prices. Larger firms like Devon Energy (DVN) are better buffered against these slides since a $0.10 or even $0.50 discount built in on natural gas prices is not as large of a hit.
SandRidge is currently trading around $7 per share, giving it a price to book of 1.1 and a forward price to earnings of 14.9. This reflects its relatively strong risk profile and its prospects for growth, and is a slight undervaluation, in my opinion, given its recent earnings coup. Chesapeake, which also did better than many expected, is currently trading around $19, with a price to book of 0.9 and a forward price to earnings of 10.0
EOG is currently trading around $111, with a price to book of 2.2 and a forward price to earnings of 17.1. EOG is enjoying a steady rise prompted by its own second quarter earnings report, which despite a leveling off could easily be on its way to a new 52-week high. Devon is trading around $60, with a price to book of 1.1 and a forward price to earnings of 8.6. Finally, Midstates is trading around $8, with a price to book of 1.4 and a forward price to earnings of 5.1, following a slide after a disappointing second quarter earnings report. Midstates is poised to grow following its recent struggle, however, since its acquisition in the Mississippian as outlined above will more than double its size and add oil-rich drilling prospects to its portfolio.
I think that Chesapeake's problems are a warning to the entire industry not to overreach in complicated deals. While the positive media bounces Chesapeake received worked awhile to prop up its stock price, the company and its stockholders are now in payback mode. I think Ward will be very careful to avoid anything similar happening to SandRidge. To me this adds attractiveness to SandRidge, since companies that are self-policing tend to outperform those that are not; with SandRidge's asset base and growing production, there is nowhere to go from here, but up.