SandRidge's Future Is Coming Into Focus

Despite slashing its capital plans for the year, SandRidge is making all the right moves.

Matthew DiLallo
Matthew DiLallo
May 9, 2013 at 2:30PM
Energy, Materials, and Utilities

Mississippian Lime-focused oil producer SandRidge Energy (UNKNOWN:SD.DL) recently reported its first-quarter earnings. It was a solid report and a really good indication of things to come. What stood out most in the report is the company's shift in strategy to become a much more fiscally conservative company.

For the past few years SandRidge had been following the aggressive growth plan that's commonplace in the industry. The strategy was simple, secure as much land as you can, develop the oil and gas that's underneath as fast as you can, and don't think twice about how much it costs. That strategy worked for a while as commodity prices skyrocketed and capital was easily accessible. Unfortunately, as the steam went out of commodity prices, it caused the wellspring of capital to run dry and with it, those ambitious growth plans.

Now, SandRidge and its peers are really getting religion, so to speak, when it comes to capital allocation and return on investment. After slashing $700 million from its 2012 capital spend, the company is now slicing an additional $300 million from what it had previously announced it would spend this year. What it's doing now is focusing its capital on the highest-return plays in a pursuit of profitable growth instead of empire building.

It's a story that's becoming commonplace in the industry. Chesapeake Energy (NYSE:CHK) for example sliced its capital plan by 39% over last year. Its previous strategy of asset capture and holding acreage by production has given way to a new strategy of capital efficiency and financial discipline. It's a similar story at Ultra Petroleum (NASDAQ:UPL) which is taking things a step further and only investing within its cash flow. That's meant a large drop in capital spending, which has gone from $1.56 billion in 2011 to $835 million last year and is now down to just $415 million this year. That's discipline the industry hasn't seen in a long time.

SandRidge now embracing this discipline means that investors can expect changes as the company's future starts to come into a clearer focus. We saw glimpses of what to expect in its most recent quarterly report. The company spent $235 million in capital to develop its Mississippian acreage in the quarter and was able to drill 122 producing wells. Last year the company spent $220 in the Mississippian and only drilled 68 wells. So, you're seeing a slight increase in capital yielding significantly more wells being drilled. That means more oil being produced which is yielding a nice pickup in cash flow.

What the company is doing is focusing its drilling close to its existing infrastructure. It has identified six core areas of focus and its investing 90% of its capital into those focus areas. By concentrating its activities in these six areas the company is able to achieve better rates of return by capitalizing on the infrastructure investments it has already made.

This change is lowering the risk profile of SandRidge in two significant ways. First, by focusing its drilling on these lower-risk areas, SandRidge can deliver a higher, more certain return. Further, by cutting its capital spending it's able to fund the company for a longer duration without seeking external capital. When it sold the Permian Basin assets the funds from that sale were enough to fund the Mississippian development thought the end of next year. Now, by reducing its development plan by an additional $300 million, it can push back that funding gap well into 2015.

The SandRidge that is beginning to emerge is a much more compelling investment opportunity than the SandRidge of old. The company has done a solid job in getting its leverage in check and pushing off its funding shortfall, both of which have significantly reduced the overall risk profile of the company. While it still has a tough climb ahead of it, SandRidge has found a much safer path.