Source: SandRidge Energy,.
So much for the long-anticipated turnaround in SandRidge Energy's (NYSE: SD) stock price. After the company sacked founder and CEO Tom Ward in mid-2013, the new management team was expected to hit its stride in 2014 and finally turn the company's stock around. The oil and natural gas producer did outperform expectations in the first quarter, leading the stock to outperform the market through the early summer. Unfortunately, as the following chart shows, things quickly spiraled out of control as the price of oil fell off a cliff.
The company has yet to recover, as the plunge in oil highlighted two well-known risks to the company's business model: its debt load and the fact that it can't grow without high-priced petroleum.
Cracks begin to emerge
SandRidge Energy's year really started to unravel with its second-quarter report. While it beat earnings estimates, production was weaker than expected due to power and weather-related disruptions in the company's core Mid-Continent operations. SandRidge also ran into water issues in the Permian Basin as it encountered too much water production and not enough oil on wells it drilled for the SandRidge Permian Trust (PER). More cracks in the foundation emerged shortly thereafter as COO David Lawler resigned to become the CEO of BP's (BP -1.17%) U.S. Lower 48 onshore business.
But the primary contributor to the stock's ill fortune in 2014 was the unrelenting sell-off in the price of oil. Sustained low oil prices could prove to be a big issue down the road due to SandRidge's weakening credit profile, which it can't do much about because of the weaker returns it will see in the Mid-Continent in today's price environment.
Weaknesses turn into worry
The chart below illustrates the company's weakening credit profile.
Source: SandRidge Energy Investor Presentation.
The company's leverage ratio has been trending higher since the second quarter of 2013. Meanwhile, its liquidity has shrunk over the past two quarters. The worry here is that SandRidge eventually could face a liquidity squeeze, which might lead to a default. In fact, energy investors are increasingly worried about the potential for a massive energy bond default wave hitting the industry as early as 2016 if oil prices don't improve.
Investors are also growing more worried about the company's returns in the current oil price environment. As the chart on this next slide shows, SandRidge Energy's well costs mean it can barely make any money drilling new wells at the current sub-$50 per barrel price.
Source: SandRidge Energy Investor Presentation.
At that price, it's simply not worth it to the company to continue drilling anywhere near its current rate. That's a problem because the company planned to drill its way out of its debt, as the growing cash flow from new wells would have reduced its leverage ratio over time. Now the company needs to retrench and only drill its best locations, but that might not be enough to keep its head above water if the price of oil stays in the $50 range for a couple years.
Investor takeaway
SandRidge Energy is in a tough spot. It needs high-priced oil to complete its turnaround plan, but no one knows when, or if, oil will rise again. This uncertainty has decimated the company's stock, and its future appears binary: the stock could go to zero if $50 oil stays for a few years, or it could rocket higher on a rebound in oil prices.
