Friend and Fool blogger Robert Zimmerman recently wrote a post entitled, "A Proven Winner, a Likely Winner and a Dud." While I agree wholeheartedly with his two winners, I have some issues with his calling SandRidge Energy (UNKNOWN:SD.DL) a dud. Let's drill down into his thesis and why I think he, and investors like him, are letting the company's spotty past cloud its future potential.
Topping the list of criticisms is CEO Tom Ward and the eerily similar "shenanigans" (as Bob calls them) to Chesapeake Energy's (NYSE:CHK) CEO Aubrey McClendon. Now, I'll be quite honest with you, I have my questions, too, and after hearing about McClendon's early retirement I wondered if Ward might be next. SandRidge, with Ward at the helm, has made many of the same mistakes as Chesapeake in taking on too much debt and betting that borrowed money too heavily on a volatile commodity.
Both men have profited wildly, and in some cases questionably. It is hard to justify how Chesapeake's Founder's Well Program and SandRidge's conflicted related-party transactions were completely aligned with shareholders. Meanwhile, investors have suffered as shares of both companies have crumbled.
However, the value in the company goes much deeper than management's ability to destroy it. Bob points out that the all-in strategy to develop the Mississippian Lime will likely be the wrong one. I don't think the numbers would agree with that.
Sure, given the recently reported poor results from SandRidge's two royalty trusts, SandRidge Mississippian Trust I (NYSE:SDT) and SandRidge Mississippian Trust II (NYSE:SDR) there is reason to be concerned. It's hard to spin the numbers as SDT's sales volumes increased just 1% due to higher natural gas production and slightly lower oil production. This led SDT to produce a 10% lower distribution per unit than was targeted. Over at SDR, sales decreased 7% due to lower oil production along with slightly higher natural gas production. That caused SDR to produce an 11% lower distribution per unit than was targeted. The key takeaway on both, oil volumes were down and gas was up, not exactly the mix you want to see on what's supposed to be an oil-levered play. However, it is still very early in the play and, more importantly, the key metrics being reported by SandRidge are a bit more positive.
This is a company that delivered 20% reserve growth, with its oil reserves growing even faster at 35%. Further, its proved reserve replacement was up 454%. Reserves are the lifeblood of an oil and gas company, so growth here is important. Production was also up and the company expects its Mississippian Lime production to jump 72% in 2013. If you can find a company growing both production and reserves, then you've found a potential winner, even better if that growth is in oil and liquids.
This is a company that's also improving its financial metrics in that core Mississippian Lime play. Drilling and completion costs dropped by 14%, or half a million dollars per well, over the year. A lot of this was due to a 20% decrease in spud-to-spud cycle time as the company has the best spud-to-first sales in its class. These are really important metrics for improving margins and cash flow; it's something you really want to see from an energy investment.
Now, I'm not saying that SandRidge is the best energy investment out there, but the company really could surprise investors. If the Mississippian turns out to be even halfway decent SandRidge could have multibagger potential because the expectations are so low. SandRidge is really an intriguing story and one worth a deeper look.