Risk is something that no one really talks about until its too late. That's why I want to stay ahead of the game and take a look a three of the specifics risks facing SandRidge Energy (NYSE: SD). These are the three areas, in my opinion, are where the current risk is the highest.
The following discussion on SandRidge's risks is part of our recently updated premium report on the company. Below is an excerpt from the report, laying out three risks investors need to watch in the coming years along with some commentary to provide some additional context. We hope you enjoy.
Risks
- Kansas acreage is still being appraised by the company. While the performance of the wells is comparable to SandRidge's Oklahoma wells, they have lower initial production with correspondingly lower decline rates. While this will yield favorable overall rates of returns, those returns will take longer to be realized. Given the company's financial situation, this isn't an ideal situation. The risk is that the Kansas acreage would slow down the company's ability to grow production and profits fast enough to make an impact.
Because of SandRidge's tight financial resources and ambitious capital program, it needs projects that can deliver high cash returns that can then be reinvested. Right now this isn't a problem as its capital program is funded through the end of next year and it has several options to fund its 2015 budget. However, at some point its wells need to produce more cash flow than the company spends in developing new wells.
- The boardroom battle continues. CEO Tom Ward could be let go this June if the board deems him not to be the right man for the job. If that happens, it could lead to another significant alteration of its strategy. The risk is that the boardroom drama would continue to drag on and become a bigger distraction for the company.
We've already seen Chesapeake Energy (CHK +0.00%) oust Aubrey McClendon so it really wouldn't surprise me if Tom Ward were next. Ward, who was also a co-founder at Chesapeake, has drawn similar ire from investors for taking the company down the same debt-fueled growth path that has been the bane of Chesapeake. If Ward stays on, shareholders will need to get behind his vision for the company. On the other hand, if Ward is removed, investors will likely be left in limbo as a new leader emerges with what could be a new direction for the company. The boardroom battle needs end soon so the company to concentrate on its operations.
- Commodity prices are a risk for any exploration and production company. Given SandRidge's limited resources, a prolonged decline in energy prices, particularly oil, could affect its returns and impair its ability to grow.
While 80% of the company's cash flow from the Mississippian is derived from oil, just 45% of the production coming out of the Mississippian is oil. That means that the company would see some nice upside to its cash flow if natural gas prices continue to go higher. On the other hand, if oil prices continue to head lower, it could really impact the company's oil-levered cash flow. While it has some hedges in place, the risk from commodity prices remains.
