Look at the Issuer
SandRidge Energy is an independent oil and natural gas company headquartered in Oklahoma City, Okla., concentrating on development and production activities in the Mid-Continent, Gulf of Mexico, and Permian Basin in west Texas. As of Dec. 31, 2012, the company had 6,082 gross (5,066.1 net) producing wells, a substantial portion of which it operates, and approximately 4,274,000 gross (2,941,000 net) total acres under lease. Total estimated proved reserves as of Dec. 31, 2012, were 565.9 MMBoe of which approximately 58% were oil, including NGLs, and approx. 57% were proved developed. In December 2012, the company entered into an agreement to sell a significant portion of its oil and natural gas properties in the Permian Basin, which closed in February 2013.
The company also operates businesses that are complementary to its primary development and production activities, including gas gathering and processing facilities, an oil and natural gas marketing business and an oil field services business, including its wholly owned drilling rig business, Lariat Services, Inc. As of Dec. 31, 2012, the company's drilling rig fleet consisted of 30 operational rigs. These complementary businesses provide the company with operational flexibility and an advantageous cost structure by reducing the company's dependence on third parties for these services.
As of Dec. 31, 2012, the company had 2,510 full-time employees, including more than 450 geologists, geophysicists, petroleum engineers, technicians, land and regulatory professionals. Of the company's 2,510 employees, 791 were located at the headquarters in Oklahoma City as of Dec. 31, 2012, and the remaining employees work in the company's various field offices and drilling sites.
Moves Toward Being More Profitable
On Feb. 26, 2013, the company sold the Permian Properties for $2.6 billion, including certain post-closing adjustments that were finalized in the third quarter of 2013. The company used a portion of the sale proceeds to fund the redemption of approximately $1.1 billion aggregate principal amount of outstanding senior fixed-rate notes, and intends to use the remaining proceeds to fund its capital expenditures in the Mississippian formation and for general corporate purposes. The premium paid to redeem these notes and the expense incurred to write off the remaining associated unamortized debt issuance costs resulted in a loss on extinguishment of debt of $82.0 million for the nine-month period ended Sept. 30, 2013, and the redemption of these senior fixed-rate notes will result in a reduction in interest expense from the anticipated total for the year ending Dec. 31, 2013, of approximately $72.8 million.
Exploration and production segment revenues decreased $31.3 million, or 6.3%, for the three-month period ended Sept. 30, 2013, from the same period in 2012, as a result of a 1,226 MBoe, or 12.9%, decrease in combined oil and natural gas production due to the sale of the Permian Properties in February 2013. The volume decrease due to the sale was partially offset by increased production from the Mid-Continent area as the company focused on its development of the Mississippian formation, as well as an increase in prices received for volumes produced. Production expenses decreased $20.4 million, or 14.8%, for the three-month period ended Sept. 30, 2013, compared to the same period in 2012 primarily due to the decrease in total production. During the three-month period ended Sept. 30, 2013, production expense was $14.19 per Boe, down from the comparable 2012 period rate of $14.51 per Boe as a result of improving efficiencies in the Mississippian area, including efficiencies gained through the use of the company's electrical transmission and saltwater disposal systems.
SandRidge's adjusted EBITDA of $252 million for third quarter 2013 compared to $297 million in third-quarter 2012, while pro forma for the sale of the company's Permian assets in the first quarter of 2013, adjusted EBITDA was $182 million for third quarter 2012. Including certain post-closing adjustments that were finalized in the third quarter of 2013, the company recorded a non-cash loss on the sale of $398.9 million, of which $71.7 million was allocated to noncontrolling interests. Additionally, the company settled a portion of its existing oil derivative contracts in February 2013 prior to their respective maturities to reduce volumes hedged in proportion to the anticipated reduction in daily production volumes due to the sale, which resulted in a loss on settlement of approx. $29.6 million. Including the impact from the sale of the Permian Properties, management said it increased its full-year production forecasts to 33.6 million barrel of oil equivalent (BOE) for 2013, up by 300,000 BOE.
In brief, SandRidge's reported earnings was well ahead of last year's third-quarter earnings and what analysts were expecting on the quarter, largely because it had shaved 22% off its lease operating expense over the past year. This includes a 5% reduction from the previous quarter. Furthermore, the company was able to hold the line on well costs, at $2.95 million. Not only has production from the company's Mississippian wells improved significantly (up over 59% from last year), but the percentage of much more profitable oil from these wells appears to have risen from 45% to 48%. SandRidge is projecting continued improvements into next year, as it sees its Mississippian production growing by 35%, and estimates its overall production will be up by 12%. The company expects to spend about $1.5 billion to do so.
Interest Coverage Ratios
Interest expenses for the quarter ending Q3 2013 appear to be $61.4 million, while operating income (EBITDA) was about $182 million, indicating a reasonably solid interest coverage ratio of about 3 times.
We Like Companies With Lower Debt-to-Cash Ratio
Total long-term debt at the end of September 2013 was $3,195 million, while cash and cash equivalents were $920 million, giving it about a 3.5-to-1 debt-to-cash ratio. Considering its improving cash flow, and a solid leverage ratio, SandRidge remains on solid financial footing as it pursues its growth plans.
We Like Companies With Good Balance Sheets
SandRidge's net debt of $2.28 billion represents less than 40% of the near $5.8 billion enterprise valuation currently given it by the equity markets. Property, plant and equipment assets also appear to be valued at about $6 billion. Considering the concerted effort in the last year to put the company back on track toward profitability and restore value to equity holders, we expect to see its balance sheet continue to improve going forward.
We Like Higher Yields
While its fundamentally sound performance improvement and its underlying assets undoubtedly contribute to the premiums that all of its senior unsecured debt issues are currently trading at, we see the high 8.5% coupon rate and the potential gains associated with the conversion option of its similarly rated (B1/B-) preferred issuance as being a much better opportunity. Regardless of where the common stock trades, preferred stock holders continue to reap the benefit of a qualified dividend paid out semi-annually either in cash or in common stock (discounted 5% of market value).
The default risk is SandRidge's ability to perform. Considering the terms of the preferred do allow the company to pay the dividend in discounted common stock, it is our opinion that the financial default risk for this convertible debt is minimal relative to its more favorable return potential. The hardest risk for us to identify is the future valuation of the stock. With that said, a relatively new CEO at SandRidge, James Bennett, appears to be moving the company in the right direction since taking the helm earlier this year. While it may yet be too early to declare a clear victory, the turnaround does appear to be well under way.
SandRidge's profitability is inherently linked to commodity market pricing for its oil and natural gas products. Furthermore, it may face increasing competition from any number of substantially larger and better financed companies, such Royal Dutch Shell (RDS.A) or Apache Corporation (APA). This convertible preferred security may have similar risks to other convertible bonds that we have reviewed, such as the 7% Carriage Convertible Preferreds; the 4.3% Tricon Capital convertible bonds, which have appreciated over 25% in the year since our first review; and the 10% TransGlobal Energy convertibles, which have appreciated over 9% in the six months since our last review of them.
Summary and Conclusion
SandRidge remains one of the more intriguing stories in the energy industry, and we think the timing is right for initiating a position in its convertible preferreds. The company appears to hold a solid portfolio of assets that have been estimated to be worth significantly higher than its current market valuation, possibly in the $9 to $12 per share range. While it may be several years yet to realize a higher valuation in
SandRidge's common share price, the combination of a capital gain from conversion along with a high 8.5 coupon providing excellent tax advantaged cash flow in the interim provide reason enough to present it as a special opportunity buy for adherents to our investment-income.net strategy.
NYSE: $5.55 - Nov. 27, 2013
Convertible Preferred: SDRXP
Callable: only after Feb. 20, 2014, if the price of the stock exceeds 130% of the conversion price for 20 of any 30 consecutive trading days
Conversion Price: $8.0125 (anytime at holder's option)
Call Redemption Price: 100
Current Yield: ~8.25%
Disclosure: Some Durig Capital clients may currently own these SandRidge Energy Convertible Preferreds.
Disclaimer: Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.