Aggression was once a huge positive for SandRidge Energy, Inc. (SD), but it seems that this has started to backfire for the company. SandRidge Energy continues to grow through its mid-continent focus, but its stock is being held back by what many investors are viewing as an overly optimistic goal sheet compared to several months ago. Its three major priorities are to bring EBITDA to $2 billion or above, fund its expenditures entirely within cash flow, and improve its credit standings overall. These are strong goals, but SandRidge intends to accomplish all three within the next three years. This has its followers wondering whether these will come at the expense of growth, or become missed targets, in which case the company's stock could sink.
Thanks to an August bond offering, SandRidge fully funded its 2012 spending. However, its 2013 program will only be funded by taking on further debt written into its plan after exhausting its anticipated cash flow. Although substantially less leveraged than it was even two quarters ago, when its debt stood as high as 4.3 times EBITDA and uncomfortably close to competitor Chesapeake Energy Corporation's (CHK), its pro forma debt for the second quarter of 2012 was 2.9 times EBITDA. This is just low enough to avoid scaring off investors in large numbers, but high enough to be a concern. Additionally, for the current forecast, SandRidge intends to keep its leverage around 3 times EBITDA, meaning substantial relief is far in the future.
Plays Are Premium, But So Are Costs
SandRidge continues to be the most active driller in the Permian Central Basin, where it is targeting the San Andres and Clear Fork, and recently started putting greater focus onto the Penn/Ellenburger formation. Although not a leader in active well count, it is a leader here in rig count, with 11 rigs running compared to its closest peer, Occidental Permian, a unit of Occidental Petroleum (OXY), with nine. The following closest peer, Apache (APA), has four.
Despite successes elsewhere, the Mississippian remains SandRidge's flagship play. Its early focus on infrastructure is allowing it to grow without undue encumbrances, while its spud to first sales schedule is faster than any other producer's in the region. With 14 wells currently reporting average rates greater than 1,000 boe per day and another 49 wells reporting between 501 and 1,000 boe per day, there is no question that SandRidge is focusing its resources in an area of great potential return, even if the overall average falls closer to 266 boe per day.
Its aggressive drilling schedule on the Mississippian is one source of the stress on its resources. By adding one rig a month for the next fifteen months to its Mississippian play, SandRidge hopes to have 45 rigs running by the end of 2013. In the Kansas Mississippian, as in other areas declared a focus, SandRidge outdrills the competition, drilling four times as many wells here than the nearest competitor, in this case, Royal Dutch Shell (RDS.A).
Drilling costs on its mid-continent plays are lower than on many other U.S. plays. In the Bakken, average costs per well are now at $8.5 million, while average costs per well are at $9 million in the Haynesville Shale. Oil heavy Niobrara shale leads to a per well cost around $3 to $7 million. By contrast, companies typically spend $2.8 to $3.5 million per well on the Mississippian. However, since SandRidge is not growing its production organically, it is paying a premium for drilling through further debt acquisition for funding. It's also important to note that its recent acquisition of Dynamic Offshore Resources, for which it paid approximately half in cash and half in stock, is what is allowing it to take on further debt for the near term. SandRidge now holds total debt of $3.55 billion, compared to $2.81 billion at the end of the first quarter.
SandRidge is currently trading around $7 per share, with a price to book of 1.2 and a forward price to earnings of 16. Apache is a much better deal by value and outlook, trading around $86 per share, with a price to book of 1.1 and a forward price to earnings of 8. Chesapeake is trading around $19 per share, with a price to book of 0.9 and a forward price to earnings of 10.5. This shows that investors are far from impressed with its efforts at a turnaround, as these are the same stagnant levels seen ever since Chesapeake's second quarter earnings resulted in slight gains. For further comparison, Shell is trading around $69 per share, with a price to book of 1.2 and a forward price to earnings of 11.0. Occidental is trading around $86 per share, with a price to book of 1.8 and a forward price to earnings of 10.5.
The lack of fear of debt and focus on being the top driller or producer or leaseholder on a focus play to the exclusion of all others that SandRidge consistently displays seems to be different than its previous strategy several months back, and one of the primarily reasons I am now bearish on the stock. This current strategy is much like the one that Chesapeake showed until recently. The close ties and even more closely related management styles between SandRidge CEO Tom Ward and Chesapeake CEO Aubrey McClendon is also a matter of some concern. I believe that McClendon's continued term in the office of CEO at Chesapeake is one reason investors are not reacting positively to Chesapeake's recent spate of deal announcements, even though these improve the company's outlook considerably.
Ward, seeing Chesapeake's track, started taking measures to improve SandRidge's credit standing earlier this year, so that SandRidge today appears in much better financial condition. A Chesapeake-style meltdown is not on the cards for SandRidge now, but a range of possibilities could change that balance, including adverse market conditions, damaging disclosures about corporate malfeasance, or a cost run up - all of which hit Chesapeake concurrently earlier this year. SandRidge has little defense against these factors as long as it is overleveraged.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.