SandRidge Energy (NYSE: SD), the Oklahoma City-based oil and gas producer, reported first-quarter financial results last week that handily beat analysts' expectations. First-quarter adjusted net income came in at $37.9 million, or $0.07 per share, exceeding analysts' estimates by $0.05 per share.

A closer look at the company's first-quarter performance reveals a number of encouraging signs, including improving well performance, potential upside from its appraisal program and new well designs, and reduced funding concerns, which suggest that shares of SandRidge could still have meaningful upside.

Photo credit: SandRidge Energy.

Improving well performance
For SandRidge, delivering strong and consistent well performance from its core asset in the Mid-Continent is key to its future, since the area accounts for the vast majority of its reserves and capital spending. With the exception of its Permian Basin assets, SandRidge is now entirely focused on the Mid-Continent after divesting its Gulf of Mexico assets back in February.

While the company's previous results from the Mid-Continent highlighted a strong degree of variability between well performance in different parts of the play, the company's first-quarter well results were quite encouraging and suggest that SandRidge is making good progress in tackling the issue of well variability and delivering more consistent results.

The company's 71 Mid-Continent wells posted an average 30-day IP of 410 barrels of oil equivalent per day, or boe/d, roughly 29% higher than the company's type curve, while seven of those wells delivered 30-day IP rates of over 1,000 boe/d -- the greatest number of high-rate wells in a single quarter since the inception  of the play. The improved well performance is due largely to incremental improvements in the company's completion techniques and success with its sub surface modeling efforts.

Cost savings potential from new well design
Another encouraging sign from the quarter was the successful implementation of a new well design in Harper County, Kan., as part of SandRidge's multilateral well testing program. The dual stacked lateral delivered a 30-day IP of 707 boe/d and was completed for just $5.2 million, compared with $6 million for two standard wells.

In other words, this new well design yielded significant cost savings while delivering production rates comparable with previous well designs. Importantly, the company believes it can implement this new well design in numerous other parts of the play and plans to bring online three additional dual stacked laterals in the second quarter.  

Judging by initial results, the company's implementation of additional dual stacked laterals should lead to significant cost savings -- roughly $400,000 per well -- while also allowing the company to access additional zones that would be less profitable using a single well design. Investors may want to keep a close eye on this initiative, as it could meaningfully improve capital efficiency and returns.

Reduced funding concerns
In previous years, one of the biggest concerns for SandRidge investors was the company's high degree of leverage and thin liquidity. But thanks to a combination of asset sales, improved capital efficiency, and growing cash flow, the company finds itself in better financial health.

As of the end of the first quarter, SandRidge had $1.18 billion in cash and equivalents, as compared with $815 million in cash on hand as of year-end 2013. Combined with $746 million of availability on its credit facility borrowing base, this provides the company with total liquidity of roughly $1.9 billion.

While SandRidge's quarter-end debt remained largely unchanged at nearly $3.2 billion, resulting in an uncomfortably high leverage ratio of around 3.0, leverage should gradually improve over the next few years as EBITDA and cash flow growth accelerate, led by an expected 20%-25% annual compound growth in production. The company also retains the option of additional asset sales to generate cash, including a potential monetization of its saltwater disposal system.

Investor takeaway
SandRidge Energy has come a long way under the leadership of its new CEO, James Bennett. The company appears to be steadily unlocking value from its Mid-Continent asset, while maintaining its industry-leading cost structure in the play. With diminished funding concerns and an improved outlook for production, earnings, and cash flow growth, SandRidge should gradually move closer to its fair value of roughly $10 per share over the next few quarters or years.