InvestorsHub Logo
Followers 116
Posts 13333
Boards Moderated 0
Alias Born 05/27/2004

Re: Tutu post# 1706

Tuesday, 12/09/2014 8:44:29 PM

Tuesday, December 09, 2014 8:44:29 PM

Post# of 13692
Investment Thesis 11/21/2014
After a series of divestitures--including its operations in the Permian Basin and the Gulf of Mexico--SandRidge has reduced its portfolio to a single core asset: the horizontal Mississippian. With a new management team in place and improved board oversight to ensure fiscal discipline, the company may finally be in a position to deliver the predictability investors have long sought. Once the impact of the recent Gulf sale is lapped, SandRidge should be able to deliver double-digit production growth for several more years, although returns are likely to suffer given the heavy investment levels required to develop the Mississippian. Accordingly, we think a takeout from a larger firm with more financial firepower would make sense.

SandRidge built its 1.8 million-acre position in the horizontal Mississippian internally. Though the company has been drilling here since 2007, it wasn't until mid-2010 that it ramped up leasing with the intent of going after the Mississippian horizontally. Under this approach, SandRidge will be "connecting" the hundreds of vertical wells that have been drilled on its Mississippian acreage over the past 30 years, using existing wellbore data to target the thick blanket depositions that emanate from source rock in the Woodford Shale. SandRidge believes horizontal drilling can dramatically increase per-well estimated ultimate recovery and reduce the uncertainty associated with drilling vertically into carbonate reservoirs. Early results appear to confirm this thesis, although it should be noted that horizontal Mississippian drilling is a relatively new industry development. SandRidge will need to push hard to hold acreage here, as most leases were signed with five-year terms. We forecast a drilling program of nearly 3,000 horizontal wells over the next five years which should allow the company to hold the majority of its acreage. We also forecast production volumes to increase almost 170% by 2018.

SandRidge should benefit from the significant investment in infrastructure it has made here over the past several years, with savings from water handling and electricity, especially, providing an advantage over competitors.

Economic Moat 11/21/2014
Asset quality is the biggest determinant of competitive position in E&P and is generally measured along three dimensions: resource potential (the number of available drilling locations and the amount of recoverable hydrocarbons at each location), per-unit production costs (which takes into account royalties, leasehold outlays, drilling and completion costs, lifting expenses, and taxes), and realized prices (which are affected by the mix of oil versus gas as well as regional differentials). Although SandRidge has successfully transitioned from gas to liquids, and even with a significant number of drilling locations yet to be developed across its vast Mississippian position, we don't believe the firm's acreage will generate economic returns for the foreseeable future, in part because of the heavy spending the firm undertook to build its leasehold position (which weighs down returns). Accordingly, we assign SandRidge a rating of no moat. If over the next several quarters the company's reconstituted board and new management team are able to demonstrate a commitment to long-term value creation for shareholders--perhaps by shedding noncore Mississippian acreage or through a monetization of its Mid-Continent infrastructure investments--we would probably revisit our moat rating.

We think SandRidge's horizontal Mississippian position has the potential to positively affect the firm's financial profile over the next several years. By 2018, we project liquids will represent 52% of production volumes, up from one third in 2010, which should lead to higher realized prices and operating margin expansion. SandRidge's lower-cost, repeatable drilling opportunities should also translate into greater capital efficiency, with improvement in its finding and development costs and recycle ratios (which measure the ratio of profit per unit of production to F&D costs). The net result should be incremental returns that exceed the firm's cost of capital by the later years of our forecast. Even beyond our five-year forecast period, SandRidge should have plenty of opportunities for additional development. By 2018, we estimate the firm will have worked through just over half of its high-graded Mississippian inventory, which targets multiple Mid-Continent formations such as the Mississippian Lime, the Chester, and the Woodford Shale. While its break-even point of $94 per barrel of oil (assuming $4 per thousand cubic feet of natural gas) is higher than some of its peers (in part because of production obligations due to trust unitholders), SandRidge's hedge book should allow it to continue growing production at a decent clip even if oil prices drop significantly.

Valuation 12/02/2014
We are lowering our fair value estimate to $6 per share from $7 after updating our oil and gas futures prices and reassessing the company's outlook given near-term weakness in commodity prices. Our fair value estimate is based on our five-year discounted cash flow model and an assessment of trading multiples, comparable transactions, and longer-term resource potential and implies forward enterprise value/EBITDA multiples of 7.3 times in 2014 and 7.2 times in 2015. While it's still in the early phases of its transition to liquids, we expect SandRidge to deliver better results than it has historically, with production growth and mix shift leading to improvement in operating margins and incremental returns on capital. We forecast aggregate net production of 475 million cubic feet equivalent per day in 2014, 584 MMcfe/d in 2015, and 665 MMcfe/d in 2016, representing a 5% compound annual growth rate over 2013 (note that this moderate growth rate is due in part to the loss of 140 MMcfe/d from the Gulf of Mexico sale in early 2014). In the Mississippian, we forecast a significant ramp-up in production, from around 310 MMcf/d at year-end 2013 to 635 MMcf/d by 2016. Our projected horizontal rig count here increases modestly over the next three years, from 25 to 29. By 2016, we expect the Mississippian to account for 90% of SandRidge's production, up from around 18% in 2011. In the absence of any new drilling activity, we project a steady decline across SandRidge's legacy natural gas fields. We expect the company to average a 382% reserve replacement ratio over the next five years, with proved reserves climbing from 2.6 Tcfe in 2013 to 5.5 Tcfe by 2018. We forecast EBITDA of $1.0 billion in 2014, $1.1 billion in 2015, and $1.0 billion in 2016, driven by production growth, improvements in average realized prices, and a modest amount of operating leverage. Projected EBITDA margins should come in well above SandRidge's 10-year historical average of 40%.

Risk 11/21/2014
As with most exploration and production firms, a sustained and significant drop in oil and natural gas prices would hurt SandRidge's profitability and reduce cash flow available for growth. Such a scenario would also weaken SandRidge's credit profile and hamper its ability to raise funds through asset sales and trust offerings. Other risks include service cost inflation, ongoing regulatory headwinds (most notably environmental concerns), and uncertainty regarding future federal tax policy.

Management 04/08/2014
SandRidge is led by president and CEO James Bennett, who took over for Tom Ward after Ward's forced departure in June 2013. Bennett had served as president and CFO since March 2013 and executive vice president and CFO since January 2011. From 2010 until he joined the company, he was managing director for White Deer Energy, a private equity fund focused on the exploration and production, oilfield service and equipment, and midstream sectors of the oil and gas industry.

With Ward gone, management and the newly reconstituted board have made it a priority to reduce corporate overhead and optimize the company's limited capital resources, while also focusing on balance sheet repair. We believe shareholders will be better served than they were under Ward's leadership.

Collectively, SandRidge's directors and officers own about 10% of the outstanding common shares of the company.

Overview

Profile:

Based in Oklahoma City, SandRidge is an independent oil and natural gas company whose operations focus on liquids-rich carbonate plays in the Mid-Continent region of the central U.S. SandRidge also owns an oil field services business, a gas marketing business, and various gas gathering and treating facilities. At year-end 2013, proved reserves were 433 million barrels of oil equivalent, with net production of 93 thousand boe per day. Oil and natural gas liquids represented 49% of production and 47% of reserves.

http://analysisreport.morningstar.com/stock/research?t=SD®ion=USA&culture=en-US&productcode=MLE

Join the InvestorsHub Community

Register for free to join our community of investors and share your ideas. You will also get access to streaming quotes, interactive charts, trades, portfolio, live options flow and more tools.