SandRidge Energy: Buy Value, Income & Safety (NYSE: SD ) | Private Equity Weekly

Sandridge Energy (NYSE:SD) is a small independent oil and gas company headquartered in Oklahoma. All of SandRidge’s assets and proven reserves are located in the “Mid-Continent” region, more specifically Oklahoma and Kansas.

The argument behind having SandRidge is one of valuation, as well as recent capital allocations. Even with its recent gains, SandRidge trades at just 4x cash flow and 9x earnings, which is dirt cheap. Additionally, the company paid a special dividend of $3.50 last year, which is a huge dividend for a stock worth about $15 per share. There is also a regular quarterly dividend, which was recently increased by 10% $0.11 per share, the yield is slightly less than 3%.Furthermore, this is a company that generates both profits and free cash flow, with over a third of its market capitalization derived from Cash, no debt and pay very little tax. In other words, the margin of safety is huge.

company analysis

From a financial perspective, SandRidge couldn’t be in better shape. Becoming an independent oil and gas business is not easy, as capital intensity and the vagaries of commodity markets impact profitability. SandRidge found this out the hard way File for bankruptcy 2016.What emerged, however, was a stronger, more sustainable business, much of which debt elimination Through restructuring.Currently, SandRidge has no outstanding debt and Warrants The plan to purchase approximately 18% of the shares issued in the restructuring expires in October 2022, eliminating a huge backlog in the company’s shares.They also held over $250 million in cash at the end of 2023 every 10-Kmanagement updated it to about $200 million during the fourth-quarter conference call after paying a special dividend in February.

SandRidge has been profitable and has positive cash flow for the past three years. General and administrative expenses ($10.7 million) were almost completely offset by interest income earned in 2023 ($10.6 million) due to growing cash balances. The company also pays little in income taxes, as a $1.6 billion net operating loss protects its tax exposure.

On the operational side, it’s a different story, as their assets are in a difficult environment and natural gas pricing has been a big issue over the past year.This doesn’t appear to be a company with unlimited potential or a strong growth roadmap, which many would argue they’re well positioned to assets The Mississippi Lime region of Oklahoma is of lower quality. This is the most likely reason why the stock is so cheap. But despite these flaws, the company’s risk is very low, as its strong balance sheet should protect it from further declines in oil or gas prices, and the stock’s margin of safety is compelling at these valuation levels.

The majority of SandRidge’s products are derived from natural gas:

However, its revenue in 2023 will mainly come from oil.

As you can see from the production chart, management is trying to shift its portfolio toward oil given price levels. They have also stated in multiple earnings calls that they will only proceed with new development or reactivate idle wells when WTI and Henry Hub prices are firmly above $80 per barrel and 4 MMBtu respectively. While we have seen WTI rise above $80, Henry Hub is currently well below that threshold and has been for quite some time.

Some may speculate that with natural gas prices so low, now is the time to buy, but I won’t even try to predict where that will go. I like knowing that my margin of safety in my stock price protects me from oil and gas price fluctuations. Not paying off debt is comforting when looking at a chart like this.

after having six CEOs After five years, there finally appears to be some stability at the helm of the company, with Grayson Pranin having held the position for nearly three years. During that time, he showed pretty good results and significant restraint. They made it very clear on the call that a merger is an attractive option for them, given that they can use $1.6 million in NOLs to protect future revenue. While valuations may be considered attractive, they have not initiated acquisitions of any size recently, preferring to make smaller, value-add acquisitions with seamless integration, such as the acquisition of Northwest Stack, which only adds to their already strong Interest in the oil wells where the business is conducted. In response to a direct question about why they weren’t more aggressive, Planin said, “The challenge is there has to be alignment between buyers and sellers.” This tells me that management insists on paying a fair price.

capital allocation

A key previous criticism of management and the board was the lack of any shareholder distributions through dividends or share buybacks, despite the importance of cash balances to its market capitalization and operating needs. Clearly, as I noted at the beginning of this article, things have changed. In May 2023, the company announced a special dividend of $2.00 per share, a regular quarterly dividend of $0.10 per share, and a stock repurchase plan of $75 million. Currently, the company has not purchased any shares following the buyback announcement, but a dividend would go a long way to appease the shareholder base. They continue to hold large amounts of cash, which they expect to use for accretive M&A, continue paying dividends, or start buying back stock. In January 2024, they announced another special dividend of $1.50 per share and increased their regular quarterly dividend. As a shareholder, this is a great situation, especially considering that management can be selective in M&A. Given their current decision to pay a special dividend rather than buy back stock, it would be more advantageous to hold this company in a retirement account to defer taxes on the dividends.

Valuation

As I mentioned above, SandRidge is cheap considering any multiple-based metric. To be fair, the trailing 12 months P/E ratio of 9x (using current prices of $15) is about the highest level in almost 3 years.

The reason was changes in the fourth-quarter deferred tax valuation allowance, a non-cash charge against revenue that offset much of the quarter’s net income. But even accounting for this accounting adjustment, SandRidge is very cheap. Its enterprise value to free cash flow (EV/FCF) ratio is only 4 times, which means the yield rate exceeds 25%.

risk

One of the reasons some investors dislike the natural resources industry is that the company has no direct control over pricing, unlike many other industries. The counterargument from investors in the industry is that there are other ways to predict where the prices of these resources will go. In the case of oil and gas, investors can point to supply and demand, demographic changes, geopolitical shocks or weather-related events as possible influences that could change perceptions of where prices are heading. Regardless of perspective, this must be viewed as a risk. If you were investing in SandRidge in 2022, you might have a view on natural gas prices, but do you expect it to drop 80%? Although astute management can mitigate this risk, it is beyond a company’s control.

The net operating loss carryforward, usually quoted accurately at $1.6 billion, is unlikely to be fully utilized, as evidenced by the valuation allowance that retains most of the deferred tax assets. Additionally, the company has taken proactive steps to protect this asset, implementing a “Tax Advantage Protection Plan,” which is essentially a poison pill to ensure that a change in control does not harm this asset. It would also make it difficult for anyone to acquire them, limiting the potential for high premiums through acquisitions. The only way to effectively utilize these NOLs is through operating performance, either organically or through acquisitions, which is why they focus on acquiring assets.

Speaking of acquisitions, making the wrong one is obviously a big problem. I’m not an expert on oil and gas companies, so I’d seek help from smarter people in the field when evaluating whatever they end up doing in this regard. But as I said above, management has earned my trust through their restraint so far, so I’m confident they’ll do their homework on any acquisition.

in conclusion

Given its pristine balance sheet, solid profitability, low valuation, and strong dividend, SandRidge Energy is a safe way to participate in the oil and gas industry. While there are other companies with better assets, SandRidge is priced at a deep discount to cash flow and should deliver revenue and upside if commodity prices cooperate. While this type of company doesn’t offer explosive growth or infinite compounding, the stock offers safe diversification for a portfolio that’s tilted toward other industries or focused on oil and gas majors.