I think analysts at Canaccord Genuity were justified in downgrading Oklahoma-based SandRidge Energy (NYSE: SD) to a "sell." Let me share some of what I found during a closer look at the independent oil and gas exploration and production company.
What's the company into?
SandRidge focuses on developing its properties in the prolific midcontinent Mississippian formation, where it holds around 1.3 million net acres. The company also owns 225,000 net acres of leasehold in the prolific Permian Basin in West Texas.
At the end of 2011, SandRidge's total proved reserves were estimated to be around 471 million barrels of oil equivalent (Mmboe), with roughly a 50/50 split between oil and gas. Out of these reserves, nearly half is developed.
Impressive operations, but some debt issues
Last year, SandRidge ramped up crude oil production by a solid 60% while decreasing natural gas production, which fell 9%. As a result, overall production grew 16% over the previous year, to 23.4 million barrels of oil equivalent, and revenue increased 52% to $1.4 billion. The company reversed a year-ago operating loss, although net income fell because of favorable tax provisions last year.
All this sounded good until I took a look at the company's balance sheet.
SandRidge carries a debt load of $2.8 billion, with debt-to-equity at an unenviable 111%. Last year's capital expenditures for exploration and production were $1.7 billion, excluding acquisitions. The company is spending a lot more than it's earning.
That's not uncommon among junior E&P companies, but what is less common is that SandRidge sold off some of its developed reserves on which it had already burned cash. The annual filing states that the company had converted 50 Mmboe of reserves from proved undeveloped to proved developed in 2011. And yet by my calculations, total proved developed reserves grew only 7.7 Mmboe in the year.
And a poor business model
This includes the sale of its Wolfberry assets, which were producing 1,600 Boe/d at the time, and 23,000 net acres in New Mexico, where production was 1,500 Boe/d. The company also sold 23,000 net acres in east Texas, which were producing approximately 4,100 Boe/d.
For a highly leveraged company with capital expenditures of nearly $2 billion and a cash balance of only $208 million, divestiture of assets seemed to be the obvious way out. Which is why SandRidge's recent announcement to acquire Dynamic Offshore for another $1.3 billion doesn't make a lot of sense to me.
Aggression: The way out?
In a bid to raise funds, the company last year spun off two royalty trusts in the form of SandRidge Mississippian Trust I (NYSE: SDT) and SandRidge Permian Trust (NYSE: PER). Buying more assets using these funds reeks of over-aggression on the part of management. The latest acquisition seems needless, and the company could have put the funds to better use. After all, capital expenditures for 2012 are pegged at another $1.7 billion.
Foolish bottom line
SandRidge looks like a risky investment right now. If you want to keep up with the latest news and analysis on SandRidge Energy, add the company to your personalized stock watchlist.
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