SandRidge Energy: Buying Value, Income And Safety (NYSE:SD)

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

The thesis behind owning SandRidge is one of valuation and more recently, capital allocation. Even with its recent runup, SandRidge is trading at only 4 times cash flow and 9 times earnings, which is super cheap. Additionally, the company has paid out $3.50 in special dividends in the past year, which is a significant payout for a stock that’s trading at around $15 a share. There’s also a regular quarterly dividend that was recently increased 10% to $0.11 per share, which is just under a 3% yield. Moreover, this is a company that generates both profits and free cash flow, has over a third of its market cap in cash, has no debt and pays very little in taxes. In other words, the margin of safety is significant.

Company Analysis

From a financial perspective, SandRidge couldn’t be in much better shape. Being an independent oil and gas business is not easy with the capital intensity and whims of the commodity markets impacting profitability. SandRidge found that out the hard way by filing for bankruptcy in 2016. However, what emerged was a much stronger and more sustainable business, with much of their debt eliminated through the restructuring. Currently, SandRidge has no debt outstanding, and warrants for purchase of approximately 18% of its shares that were issued in the reorganization expired in October 2022, eliminating a huge overhang on the stock. They also hold over $250 million of cash at the end of 2023 per their 10-K, which management has updated in their Q4 conference call to approximately $200 million after the payout of the special dividend in February.

SandRidge has been profitable and had positive cash flows for the last three years. With its burgeoning cash balance, the interest income it earned in 2023 ($10.6 million) almost completely offset its G&A expense ($10.7 million). It also pays very little in income tax due to $1.6 billion in Net Operating Losses which shields its tax exposure.

Operationally, it’s a different story as their assets are in a difficult environment and natural gas pricing has been a big problem over the past year. This does not appear to be a company that has limitless potential or a strong growth roadmap and many would argue that the positioning of their assets in the Mississippi Lime region of Oklahoma are of lower quality. This is the most likely reason for the stock being so cheap. But despite these flaws, the company represents very low risk due to its strong balance sheet that should protect it against a further decline in oil or natural gas prices and the margin of safety of the stock price at these valuation levels is compelling.

Most of SandRidge’s production comes from natural gas:

Yet, its 2023 revenues have been mostly derived from oil.

As you can tell from the production chart, management is trying to shift its portfolio towards oil, given where prices are. They have also stated in numerous earnings calls that new development or reactivation of inactive wells will only happen when WTI and Henry Hub prices are firmly above $80 per barrel and $4 MMBtu, respectively. While we have seen WTI move above $80, Henry Hub is currently much lower than this threshold and has been for quite some time.

Some might speculate that with natural gas prices this low, the time to buy is now, but I won’t even try to predict where this goes. I feel comfortable knowing that the margin of safety I have on the share price gives me protection from the volatility of oil and gas prices. It’s comforting having no debt to service when looking at a chart like that.

After having six CEOs in five years, the company finally seems to have some stability at the helm, as Grayson Pranin has now held the role for almost three years. In that time, he’s shown pretty good results and a remarkable amount of restraint. They have been very clear on their conference calls that M&A is an attractive option for them given the $1.6 million of NOLs that they can use to shield future income. Despite what may be perceived as attractive valuations, they have not pulled the trigger on anything of size recently, preferring smaller, accretive acquisitions with seamless integrations such as the Northwest Stack purchase, which merely increased their interests in wells where they already had operations. In response to a direct question on why they are not more aggressive, Pranin said “the challenge is you have to have alignment between the buyer and the seller.” This tells me that management is sticking to its guns on paying a fair price.

Capital Allocation

A major criticism of management and the Board previously was the lack of any shareholder distributions through either dividends or share repurchases, despite a cash balance that was significant in relation to their market cap and operational needs. Clearly, as I indicated at the beginning of this article, that has changed. In May 2023, the Company announced a $2.00 per share special dividend, a $0.10 per share regular quarterly dividend, and a $75 million share repurchase plan. Now the Company has yet to purchase any of its shares after announcing the buyback, but the dividends went a long way towards appeasing the shareholder base. They continue to hold a high amount of cash and the expectation is they will use it for either accretive M&A, continue with the dividends or begin to repurchase shares. In January 2024, they announced another special dividend of $1.50 per share, plus an increase in the regular quarterly dividend. It’s a good situation to be in as a shareholder, especially with how selective management has presumably been in M&A. Given their current decision to pay special dividends rather than repurchase shares, it’s more advantageous to hold this company in a retirement account in order to defer taxes on the dividends.

Valuation

As I mentioned above, looking at any multiple based metric, SandRidge is cheap. Though to be fair, the PE ratio at 9x (using a more current price of $15) on trailing 12-month earnings is about as high as it has been in almost 3 years.

The reason for that was movement of the deferred tax valuation allowance in Q4, a non-cash charge against income, which eliminated most of its net income in the quarter. But even taking into account this accounting adjustment, SandRidge is very inexpensive. Its Enterprise Value to Free Cash Flow (EV/FCF) is only 4x, which is a yield of over 25%.

Risks

One of the reasons that some investors do not like the natural resources sectors is that the companies cannot directly control pricing, which is different than many other industries. The counterargument by investors in the industry would be that there’s other ways to predict where prices are going for these resources. Using oil and gas as an example, investors could point to supply and demand, changes in demographics, geopolitical shocks or weather-related events all having an impact that could alter one’s view on the direction of prices. Whatever the viewpoint, this would have to be seen as a risk. If you invested in SandRidge in 2022, you could have had a viewpoint on the price of natural gas, but did you expect it would decrease by 80%? That’s a risk that is out of the control of the company, though it can be mitigated by savvy management.

The Net Operating Loss Carryforwards that are often accurately quoted of $1.6 billion are not likely to be entirely used, as evidenced by the valuation allowance that is reserving most of their deferred tax asset. Moreover, the company has taken proactive measures to protect this asset by implementing a “Tax Benefits Preservation Plan”, which is essentially a poison pill to ensure that a change of control would not impair this asset. It also will make it very difficult for anyone to acquire them, which limits any potential of a large premium through acquisition. The only way to effectively use these NOLs will be through operating performance, either organic or acquired which is why they are focused on acquiring assets.

Speaking of acquisitions, making the wrong one would obviously be a major problem. I’m not an expert in oil and gas companies, so I’d look to much smarter people in this area when evaluating anything they end up doing on this front. But as I have stated above, management has earned my trust through their restraint thus far, so I believe that they would have done their homework on any acquisition.

Conclusion

SandRidge Energy is a safe way to play the oil and gas sector given their pristine balance sheet, solid profitability, low valuation, and strong dividends. While there are other companies with much better assets out there, SandRidge is priced at a meaningful discount to cash flows and should allow for income as well as upside if commodity prices cooperate. While this type of company doesn’t offer explosive growth or unlimited compounding, the stock offers safe diversification of a portfolio weighted towards other industries or heavily focused on oil and gas majors.