For a multitude of reasons, there are times when a company trades at a considerable discount to the value of the underlying business. Within the energy sector, I think I've found a stock that the market may be unfairly discounting. It's a small-cap oil-focused producer with some very valuable assets. And it could be significantly undervalued.
A natural-gas-focused beginning
I'm talking about Oklahoma City-based SandRidge Energy
CEO Tom Ward started SandRidge in 2006 after leaving Chesapeake Energy, where he served as chief operating officer. The company's first purchase was a gas field in West Texas. As Mr. Ward recounts, SandRidge was originally a natural gas story, predicated on the then-prevalent belief that natural gas prices would stay above $7/mcf.
The early shift to oil
But by 2008, the company's management believed natural gas prices were headed much lower. Later that year, SandRidge hedged all of its natural gas production for two years with a new and steadfast focus on oil. Since that time, the MMBTU price for natural gas has fallen to just a fraction of the price of oil. With the benefit of hindsight, this was an incredible strategic move.
Had it remained a natural gas company, it almost certainly would have languished. The few natural-gas-heavy companies that have managed to hang on despite the depressed prices are low-cost producers such as Ultra Petroleum
A focus on low-risk, conventional assets
While competitors like Kodiak Oil & Gas
SandRidge was one of the first movers into the Mississippian and one of the first companies to grasp the true scope of the play. As a result, it was able to scoop up a massive acreage position at a very appealing price. I think it's worth taking a closer look at just how valuable the company's Mississippian assets might be and why the company could be significantly undervalued.
The SandRidge strategy: Buying great assets at dirt cheap prices
SandRidge originally acquired 2 million acres in the Mississippian for $400 million, at an average cost per acre of $200. It then monetized roughly a quarter of this acreage, 550,000 acres, to be exact, through joint ventures and royalty trusts, the net proceeds of which brought in a whopping $2.33 billion at an average price per acre of around $4,200.
The four monetizations included the SandRidge Mississippian Trust I
The Mississippian acreage that SandRidge still retains, roughly 1.5 million acres, has an implied value of some $6.35 billion. If you add up the proceeds from the sale of that 550,000 acres and the current value of its retained acreage, you get roughly $8.7 billion. That's $3.5 billion more than the company's current enterprise value -- from just one play alone!
While the Mississippian is its main focus, let's not forget the other assets SandRidge has. It scooped up some superb Gulf Coast assets through its acquisition of Dynamic Offshore earlier this year, once again at a very appealing price. It also maintains significant positions in the Permian Basin that have a PV-10 value (the present value of the future estimated revenues from its proved reserves) of $3.9 billion. And lastly, it still has the gas field in West Texas it bought way back in the day.
The long-term value of all these assets, in my opinion, isn't reflected in the stock price, which currently sits under $7.
Reasons to pause and final thoughts
Despite its attractive assets and value-accretive strategies, the company is certainly uncomfortably leveraged. SandRidge's capital spending consistently exceeds cash flow and liquidity. But management is well aware of this and improving credit and leverage metrics is a key focus of its three-year plan.
I think the company will eventually be able to bridge the gap between capex and cash flow and hopefully achieve its plan of tripling EBITDA and doubling oil production by the end of 2014. Oil prices still remain the biggest downside risk but the company is well hedged.
If it can continue to keep costs down and meet its production targets, I think this stock has tremendous upside. In an interview this year, CEO Tom Ward said, "I don't know when our stock will move, but you can't triple EBITDA in three years and not have your stock price double or triple along with it." For investors with at least a three-year time horizon, I think SandRidge presents an excellent opportunity.
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