SandRidge (SD) is a small oil and gas exploration and production company headquartered in Oklahoma City. Its main geographic focus is in West Texas and Mississippi. Its most prominent holding is the West Texas Overthrust (WTO). SandRidge also provides services for other oil and gas companies, such as drilling, treating, marketing, transporting, and gathering oil and gas, through its Lariat Services subsidiary. SD owns a fleet of 43 rigs. With this year’s oil-weighted Arena Resources acquisition, the company has enhanced its crude reserves.
The company earned a profit of $0.09 a share in 2007 on revenues of $677 million, but lost a combined total of $11.66 a share in 2008 and 2009, when energy prices fell, and SD had to write off reserves and service a considerable debt load (see below). However, sales and earnings should reach $900 million and $0.30 a share, respectively, in 2010, as the company concentrates more on its oil drilling operations, specifically the newly acquired Arena Resources. Of the 16,600 potential drilling sites SD has targeted in its portfolio, 7,220 represent possible oil drilling locations. Natural gas, though, still comprises the majority share of production (we estimate 220 million cubic feet per day in 2010, and around 18 million barrels of oil per day). Natural gas prices are not expected to rise much, if at all, anytime soon. In addition, although SD is expected to earn about $0.30 a share this year, about $0.20 of this is likely to stem from gains on derivatives contracts. Chairman and CEO Tom Ward has vast experience in the oil and gas business. Prior to heading up SandRidge, he was the co-founder of Chesapeake Energy. He has, therefore, become very astute at hedging gas futures contracts to avoid losses.
Although less than 20% of total revenues are derived from outsourcing services, this segment is growing steadily, and should attain 25% of sales by 2012. This unit acts as an income stabilizer, offsetting the more volatile oil and gas E&P operation. The latter business has a high operating leverage. This means that it would only take a small increase in gas prices (due to an abnormally cold winter) to send the operating margin (and, therefore, the bottom line), up quickly.
Sandridge has a very high debt load. As of June 30th, it had negative shareholders’ equity of $118 million, and long-term debt of $2.75 billion. The balance sheet should have improved a bit by September 30th, thanks to the issuance of equity to buy Arena Resources, and the use of proceeds from the sale of noncore assets to pay down borrowings. The company is proposing to sell off its sought-after Wolfcamp and Bone Spring/Avalon holdings in the next 18 months for up to $400 million. But considering Sandridge is anticipating spending $875 million on maintaining capital expenses, the amount of cash flow generated from operations will be important, particularly in light of the considerable debt-servicing requirement. SD also has a $500,000 preferred stock issue that pays out an $11.8 million annual dividend. Capex can be curtailed if cash flows decline from expected levels, or the company cannot obtain further funding on attractive terms. The company has $1.04 billion in debt due in the next five years, and $2.6 billion due by 2020. The average annual interest rate works out at about 8.75%.
Investor expectations appear to be very low. The stock has fallen precipitously in the last two years from a high of almost $70 a share in June 2008, to the current level, which is bouncing off all-time lows.
Mr. Edward Maran CFA, co-manager of Thornburg Value Fund (TVA), sees natural gas prices headed higher in the intermediate term, and feels that due to the stock’s low price, investors are valuing the company’s substantial gas assets at zero. As such, when gas prices rise, and SandRidge’s significant operating leverage kicks in, profits should increase markedly and subsequently, the stock price should rise quickly. Meanwhile, profits from the oil assets and the servicing business should be sufficient to sustain the company’s short-term cash flow needs and, in particular, service the debt.
We agree, but feel that investors should note that a great deal hinges on natural gas prices rising. Should they remain at current levels for a protracted period of time, and perhaps even go lower, the stock could decline further. In addition, the debt level is very high in relation to shareholder’s equity, and although SD has a veritable plethora of development projects on which to spend capital, especially after the Arena acquisition, it is only planning on spending $25 million on exploration, compared with $850 million on development. It should also be remembered that due to the moratorium in the Gulf of Mexico, many of the larger multinational Petroleum producing companies are moving inland, and are thus creating considerable competition for the smaller players, such as SandRidge.
In a nutshell, although upside potential is large, this is a highly speculative issue suited solely for the risk tolerant investor.