Earlier this year, SandRidge Energy (SD) President and COO Matt Grubb announced at the Kansas Independent Oil & Gas Association convention that the firm anticipates drilling 200 wells in Kansas in 2013, which will allow it to maintain its position as a leading driller in the state. Its average production per well across Kansas and Oklahoma is 325 boe per day. SandRidge is more focused on the Mississippian Lime in these two states than on any other play in its portfolio. It currently claims 1.75 million acres of leasehold on the play, representing over 8,000 identified potential drilling locations.
Even with its expanded drilling schedule, SandRidge's spending through 2013 is fully funded, although it only met that parameter through a series of complicated deals including a royalty trust IPO. SandRidge learned from its close call with bankruptcy a few years ago, and started focusing on keeping its capital expenditures reigned in in 2011. I think it's far better for SandRidge to meet its funding through these deals than to fall short, but there are inherent risks in its strategy.
Debt Profile is the Major Concern
Chesapeake Energy (CHK) is demonstrating those risks in a dramatic way, as in previous years that firm undertook complicated deals similar to SandRidge's and now that the bills are coming due , Chesapeake is failing to meet its funding needs. In 2011, as SandRidge was repositioning itself as a fiscally responsible firm, Chesapeake CEO and then-Chairman Aubrey McClendon tried to play down Chesapeake's funding problem as a simple strategy that involved spending more capital than it has cash flow "on purpose." Although many think McClendon learned much of what he knows from the mentorship of SandRidge CEO Tom Ward, the last twelve months show that the two leaders' views on how to survive in this energy market are rapidly diverging. While that's bad news for Chesapeake, it's good news for SandRidge, as the more distance SandRidge can put between itself and the slowly imploding Chesapeake the better it will look to investors.
Although at first glance SandRidge is making great strides towards reducing its net debt / total cap ratio, this has as much to do with the firm's growth as it does with payments. In the second quarter of 2010, SandRidge carried debt equivalent to 104% of its market cap. In the second quarter of 2012, its pro forma numbers indicated its debt equivalent fell to 39% of its market cap. However, its market cap at the close of the second quarter of 2010 was just $1.62 billion, compared to $3.04 billion today. While this still makes SandRidge a healthier company, these numbers should not be taken at face value. The positive here is that through recognizing its danger, SandRidge managed to keep total debt essentially flat, while its leverage ratio declined thanks to growth.
The story for SandRidge could be much worse; without Ward's early call for a shift to liquids, SandRidge could be riding the same boat as Encana (ECA). Indeed, Encana has a similar debt to equity ratio, currently at 1.4, but its utter failure to move towards liquids until recently resulted in net losses of nearly $3 billion year to date. Continental Resources (CLR) is also carrying significant debt, with a debt to equity of 0.8. However, the firm's apparent track, which positions to beat its previous five year growth plan to triple production by 18 months is helping offset concerns, as are its highly detailed plans to become a "super independent," which among other things involves Continental maintaining its current debt picture while building cash flow through its current inventory.
Pioneer Natural Resources (PXD) is carrying a debt to equity ratio of 0.6. This is right below the industry average, though it is ticking back up after reductions throughout 2011. Although the majority of Pioneer's 2012 capital program, 62%, is funded through operating cash flow, it is now carrying $3 billion in net debt.
Compared to these competitors, SandRidge has a less attractive debt position than its optimistic reports tend to suggest and unfortunately, SandRidge's credit metrics are not improving quickly enough to impress investors. SandRidge is relying on EBITDA growth through 2012 and 2013 to support the $1 billion in additional debt it took on in its August bond offering. SandRidge's estimates for its EBITDA growth are lofty; from 2011 EBITDA of $726.3 million, SandRidge hopes to reach EBITDA totaling over $2 billion by 2014. Its probability of reaching this goal relies on repeating its past performance over the next three years, though it is worth noting that between 2010 and 2011 SandRidge did double EBITDA, from $309.3 million to $726.3 million.
SandRidge is currently trading around $6 per share, with a price to book of 1.1 and a forward price to earnings of 14.3. Chesapeake is trading around $20, with a price to book of 0.8 and a forward price to earnings of 11.3. Continental is trading around $71, with a price to book of 4.6 and a forward price to earnings of 15.2. Pioneer is trading around $105, with a price to book of 2.3 and a forward price to earnings of 19.2. Finally, Encana rounds out the bottom, trading around $23 with a price to book of 2.4 and a forward price to earnings of 29.8.
I would like SandRidge better if it focused on paying down its debt rather than shifting its obligations forward with new bond offerings. At the very least, SandRidge is easing off on its packaging of royalty trusts, probably because it started selling off its non-core assets to raise cash more quickly. The poor performance of its early trusts are likely also a factor; SandRidge Permian Trust (PER) is down 25% from its 52 week high, while SandRidge Mississippian Trust I (SDT) is down over 50%. SandRidge's own performance is commensurate with its spinoffs, down about 30% from its 52 week high. This indicates that for those willing to ride with SandRidge's risk profile without the benefit of a dividend, now is a good time to buy.
SandRidge will release third quarter earnings on November 8.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.