Is SandRidge Built to Succeed?

As earnings season for oil and gas companies wraps up, you can spot an unmistakable trend among exploration and production companies. Companies with natural gas production as a large chunk of their operations are slowly shifting their focus to oil production. That's not really surprising, though, given the current lousy market for natural gas.

SandRidge Energy (NYSE: SD  ) is one company trying to make the shift. But will this transition ultimately prove to be successful? The company's first-quarter results should throw some light on that. But things don't look too promising for the future.

Numbers don't lie, but they can be made to look attractive
Net loss narrowed to $232 million, or -$0.58 per share, from $316 million, or -$0.79 per share, a year ago. However, after adjusting for noncash items and notional loss on sale of assets as well as adding back distributions made on preferred dividends, SandRidge realized a $21 million profit. This is quite encouraging, since a similar adjustment still ended up yielding a $7.7 million loss last year. At a glance, a concentrated effort to increase oil production looks like a step in the right direction.

Daily average production of oil increased almost 33% to 38,000 barrels. At the same time, natural gas production fell 9% to 175 million cubic feet per day. On an oil equivalent basis, liquids constituted 56% of total production, up nine percentage points. All this translated into a 22% increase in net realized price per barrel of oil equivalent to $55. While all this sounds good, will the strategy really be successful in the long run? I doubt that.

No free lunch
Average cost of production per Boe, including depletion costs, shot up by 10% to $39. You might say that still sounds good, after all, net realized price shot up 22%. However, the problem is that in the first quarter, the newly acquired Dynamic Offshore Resources was yet to add to production. The acquisition was completed only in the past month. Dynamic, which has oil reserves in the Gulf of Mexico, will be a different ballgame altogether. The reason being that offshore lease operating expenses will be way above what SandRidge normally encounters. While SandRidge plans to drill 13 wells by itself, it'll also participate in two nonoperated wells in the Gulf this year.

The company already pegs offshore lease operating expenses at $34/Boe, which is way, way above the average of $29.26/Boe in the year-before quarter. That's not too enticing for investors. Production costs in certain circumstances can comfortably overhaul net realized price -- unless, of course, natural gas prices see some sort of revival. In short, relying on offshore oil production to boost revenues may not be the best move.

An eyewash?
Stop-gap measures used by E&P companies with substantial natural gas assets -- like increasing liquids production -- will not result in profitability in the long run. This is especially true for companies whose balance sheets are loaded with debt. Chesapeake Energy (NYSE: CHK  ) has been focusing more on liquids, but first-quarter results have been far from impressive. Apparently, leveraging didn't do the company any good. Additionally, having a CEO whose name has been dragged into controversy won't help things either.

A dragon to slay
Similarly, SandRidge carries a debt of $2.8 billion, with debt-to-equity at 118%. That makes things look downright scary given that natural gas prices are not showing any signs of improvement. The company will understandably keep on reducing natural gas production and will either have to keep the assets on the sideline or try to liquidate them.

In the process, the two spun-off royalty trusts, SandRidge Mississippian Trust I (NYSE: SDT  ) and SandRidge Permian Trust (NYSE: PER  ) , could bear the brunt. Poor decisions taken in the past could come back to haunt management.

Foolish bottom line
Investing in this stock makes little sense right now. The company seems to be at the mercy of natural gas prices, and possibly its creditors. Additionally, with CEO Tom Ward's name dragged into the hedge-fund scandal plaguing Chesapeake, shareholders may have another reason to be wary about this company. Keep abreast of the situation by adding SandRidge Energy to your free watchlist.

Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (5) | Recommend This Article (10)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 15, 2012, at 4:05 PM, zkridge wrote:

    SD has already made the shift to an oil company. No mention that 85%+ of revenues comes from oil production? No mention that they're 80%+ hedged this year and next. No mention of 80%+ IRR (per yr) of MISS + PER wells with 15yrs of inventory. No mention that cashflow increased by 50% to $150mm for the quarter (33% increase in EBITDA). How about annual cash flow of $600mm+. Debt/cashflow for the year should be below 5x on a TTM basis this year. Looking forward debt will fall below 3x this time next year. Why no mention that there are no significant maturities until 2018? Many more facts to recite, but why worry about the details? Right?

  • Report this Comment On May 15, 2012, at 4:37 PM, propdiv wrote:

    I'm confused. Yesterday, Motley Fool'sBrian Pacampara highly recommended SD. Which is it?

  • Report this Comment On May 15, 2012, at 5:42 PM, MD22 wrote:

    This Simon guy is out of his mind.SD is nearly out of the nat gas business. Maybe !0 % of its business. Plus its got strong hedges in liquids. Simon is drinking the Kool aid. SD will hit $20 in 2 years.

  • Report this Comment On May 18, 2012, at 4:51 PM, joebdiv wrote:

    The BS is a concern, but otherwise this is analysis is off the mark. Disappointing.

  • Report this Comment On May 18, 2012, at 8:48 PM, dalemx wrote:

    We will be dependent on the stuff for 100 yrs yet.

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