A few days ago I participated in the Motley Fool's analyst roundtable and selected the one stock that I thought would be a great buy this month. That stock, SandRidge Energy (NYSE:SD) is one that I've been following closely over the past year. Based on what I've seen in the company over that time, I've decided to take my own advice this month and will be adding it to my portfolio as soon as trading rules allow.
I've boiled my SandRidge thesis down to three key points which when taken together lead me to believe that SandRidge is a special opportunity and that the time to buy is now.
The focused opportunity
SandRidge's asset portfolio has undergone several changes over the past few years. Today, the bulk of its portfolio consists of its core Mississippi Lime acreage and some shallow Gulf of Mexico operations. While the play isn't as oily as the company had hoped, the potential is there for it to be developed into an exceptional asset generating outstanding rates of return.
What I like here is that SandRidge is getting better at finding the oily parts of the play. Last quarter its Mississippian oil production rose from a mix of 45% oil and natural gas liquids to 46%, which might not sound like much. However, when 80% of the company's Mississippian cash flow comes from oil any improvement in its production mix hits the bottom line. Overall, as the industry develops the play, it's finding the oilier sweet spot.
Looking at last quarter's numbers Devon Energy (NYSE:DVN) and Chesapeake Energy (NYSE:CHK) both reported solid numbers from the play. Devon was able to bring on 24 wells, and several had initial 30-day production rates between 600 and 1,000 barrels of oil equivalent per day. Meanwhile, Chesapeake's top well in the play achieved a peak rate of 1,485 barrels of oil per day. These numbers, as well as those reported by SandRidge, show the play's potential.
The improved fundamentals
When you combine the potential of the Mississippian with SandRidge's own improving fundamentals it speaks to a compelling opportunity. In almost every metric SandRidge is improving. For example, oil as a percentage of its production is increasing, its well costs are declining, and the leverage ratio has been cut substantially. The company has shifted from growth at all costs, to a more measurable and prudent growth rate. That being said, growth is still exceptional with double-digit production growth overall, which is being driven by 60% growth from the Mississippi Lime.
SandRidge still has a long way to go, but I like the direction it is heading. I also like the fact that the company's capital plans are fully funded through then end of next year. It has several options at its disposal to extend its funding through 2015. Compare this to Chesapeake Energy which still has a billion-dollar gap to bridge this year. SandRidge is in its best financial position in years which removes a big risk as it invests to grow production.
For me, the two points above would be a compelling enough to buy shares of SandRidge. However, there is one looming catalyst which, in my opinion, means investors should buy sooner rather than later. You see, this catalyst comes with a very specific timetable.
The newly expanded board of directors has until June 30 to determine if CEO Tom Ward stays with the company. My gut feeling tells me that Ward will be joining the former Chesapeake Energy CEO in an early retirement. That could be the outcome of the board's decision at the end of the month, or if the board allows him to say, he might not stay long, as a majority of the board will then be made up of nominees from activist investors pushing for change.
So far, the activists have been, well, active. We've already seen SandRidge begin to focus its operations, cut its spending and give up on some of its overly ambitious plans. I don't see the newly constituted board stopping now, meaning that the company could explore strategic options to unlock some of its vast value potential.
I want to get ahead of this opportunity which is why I think that buying shares around $5 is a very compelling price to pay for the stock. However, because of the uncertainty surrounding SandRidge's future, this could be a bumpy ride. What I like to do in situations like this is to buy some shares and write puts to target additional shares cheaper. Specifically, my plan for SandRidge is buy half of my intended allocation outright and then write September $5 puts to try and fill out the rest of my allocation. The option income will help cushion any blow if shares initially react negatively to the board's decision at the end of the month.
Foolish bottom line
SandRidge Energy is one of the more compelling opportunities in energy today. It has a great position in an emerging oil and gas play, its fundamentals are improving across the board and it has a time sensitive catalyst. I like what I see here, which is why I'm buying SandRidge this June.
Fool contributor Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy and has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.