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There are times when some otherwise promising companies can get unduly beaten down for events that don't affect the material success of the company. I think I may have found a small-cap oil producer whose value the market could be overlooking for a number of reasons.
Making all the right moves
There are many reasons to like SandRidge Energy (NYSE: SD ) . After an early shift from natural gas to oil, the company continues to grow oil production at a breakneck clip. It has some incredibly valuable assets in relatively low-risk and less expensive conventional onshore plays. And it has a management team that has consistently made some great strategic moves, as unpopular as they were at the time.
But unfortunately, the market doesn't agree with me. In my opinion, the long-term value of SandRidge's assets isn't reflected in the stock price, which currently trades nearly 30% below its 52-week high.
So why does the stock get no love?
Skepticism regarding the three-year plan
SandRidge has a very aggressive three-year plan, which aims to triple EBITDA and double oil production by the end of 2014. To meet these targets, the company's spending program has exceeded available cash flow and liquidity. As a result, it has racked up quite a bit of debt and is vulnerable to shortfalls in outside financing.
In terms of raising capital, SandRidge's preferred avenues are joint ventures and trust vehicles. Its two royalty trusts, the SandRidge Mississippian Trust I (NYSE: SDT ) and the SandRidge Mississippian Trust II (NYSE: SDR ) , brought in more than $900 million and were fairly successful in their own right.
An unpredictable management team
Another reason the stock is hurting might be what some consider an unpredictable management team. For example, earlier this year, SandRidge was quick to acquire Gulf of Mexico producer Dynamic Offshore. The move blindsided analysts and shareholders alike, who were under the impression that SandRidge would be reducing its offshore exposure, not increasing it.
But looking back, the move may have been a great one. Not only was it consistent with the company's goal of doubling production and tripling EBITDA, but it was also immediately accretive to cash flows and earnings. It increased production by 25,000 barrels a day and helped de-lever the balance sheet. And even though the move seemed to come out of left field, it was actually consistent with the company's strategy of acquiring undervalued oil assets.
Some potential investors may also be cautious of SandRidge because of what some consider outrageous executive compensation. Total key executive compensation soared from around $19 million in 2009 to $28 million in 2010 and finally to a whopping $44 million last year. And CEO Tom Ward's annual compensation jumped from nearly $14 million to a little over $25 million over the same period.
By comparison, the CEO of Kodiak Oil & Gas (NYSE: KOG ) , a comparable company by market capitalization, took home just around $1.5 million last year. Even the CEO of ExxonMobil, arguably the most profitable company in the entire world with a market cap more than 100 times that of SandRidge, received an annual compensation of just under $35 million last year -- only $10 million more than Ward.
Involvement with Chesapeake hedge fund scandal
Another reason investors might be suspicious is Ward's involvement with Chesapeake Energy (NYSE: CHK ) CEO Aubrey McClendon outside their professional relationship during his tenure at Chesapeake. The two started a hedge fund, Heritage Management Company LLC, which listed its mailing address as Chesapeake's headquarters.
While this certainly gives reason to pause, there is no evidence that Ward used insider information collected from Chesapeake's operations. In SandRidge's first-quarter earnings call, he briefly addressed the issue, arguing that the fund's operations were conducted by a separate group of professionals hired to manage its day-to-day activities.
Upon a closer review, I think Ward's involvement is less contentious than McClendon's and probably isn't a big enough reason to overlook the merits of his company and his leadership as CEO. But I completely understand if this sours your opinion of the company.
To sum it up, there are good reasons the market is skeptical of SandRidge. But of all the issues I've discussed, I'm most concerned about the company's high degree of leverage, though executive compensation and the involvement with McClendon's hedge fund is equally unnerving. While I think the company can achieve its three-year plan, I'll concede there are plenty of reasons to be suspicious.
However, I think the biggest reason this stock could outperform over a three-year time horizon is this: Its enterprise value of around $6.3 billion is significantly less than the net asset value of its assets. While I think the company's own estimates of the combined net asset values of its Mississippian and Permian acreage seem overly optimistic (they put the number at over $30 billion), more conservative estimates still suggest that the company could be significantly undervalued on this basis.
To learn more about the strengths and weaknesses of SandRidge and what to expect from the company going forward, be sure to check out this brand-new premium report our analysts have put together. Get started.