SandRidge Energy (NYSE:SD) has returned to growth in oil production, as announced in its recent quarterly update. This is crucial given its greatly reduced valuation. After being forced into bankruptcy and struggling after emergence, the company building cash position is now accompanied by growth in oil production, allowing cash flow to increase despite lower commodity prices in Q3 compared to Q2.
There were five items from SandRidge’s recent quarterly report worth highlighting, before further discussion below. These are excerpted from the press release with my commentary, and I have highlighted them on Twitter the afternoon of the announcement:
1) Adjusted EBITDA generated of $54.8 million in the third quarter, compared to $53.7 million in the previous quarter. A higher EBITDA despite lower commodity prices in Q3 compared to Q2 is noteworthy.
2) Third quarter 2022 production of 17.8 Mboe/d was in line with the last three quarters as the Company continues its well reactivation program and begins to bring new wells online as part of its development program previously announced investment. Flat overall production with a substantial FCF is excellent.
3) SandRidge has entered into commodity derivative contracts for natural gas. Commodity derivative contracts have an average strike price of $8.39 per MMBtu with a positive asset value at market price of $4.0 million as of September 30, 2022. Profitable hedging is rare and adds value.
4) Good new wells: SandRidge operated one drilling rig in the third quarter and successfully drilled and completed three wells in the core of the NW stack – which helped increase oil production by more than 25% compared to compared to the previous quarter. The resumption of oil growth while increasing the net cash balance is impressive.
5) Rate of decline of PDP flattened: The well reactivation program has helped to flatten the projected annual decline of PDP to an average of approximately 8% over the next 10 years. A low rate of decline means low capital intensity, which can allow for a high FCF, as evidenced by the net increase in cash despite the active capital program and the growth in oil production.
This is an impressive set of achievements for a quarter for any oil and gas company. This is particularly impressive given the low valuation of SandRidge which trades at – less than 3x EV/EBITDA. Especially in the context of the 8% PDP decline rate disclosed by SandRidge – the amount of its production would decline if it did not invest capital to support that production. 8% compares favorably to peers with decline rates typically in the 20-40% range.
As SandRidge continues to build its cash balance, up to $240 million as of September 30 against a market capitalization of $680 million, pressure continues to mount on the company and its board of directors to return capital to shareholders. This remains the most frequently expressed complaint or concern from current and former shareholders.
The current board having been elected in a proxy battle led by Carl Icahn in 2018 over a promise to wind up the company and return the proceeds to shareholders. As noted at the time, “In the fight against SandRidge’s proxies, Icahn’s reputation for turnarounds is at stake” and this hoarding of cash seems contrary to Icahn’s promises at the time as well as his many appeals to other companies holding cash to return it to shareholders through buyouts or dividends.
This tension and the discounted valuation that accompanies it could represent an opportunity. The cash balance has grown by more than $140 million so far in 2022. It’s likely getting harder for other activist fund managers and other oil and gas companies to ignore. With Icahn owning less than 14% of the company and with the board of directors owning less than 1% of the company, it seems like a matter of time.
In the recent conference call, management disclosed an estimated value of proven developed reserves of over $800 million, which together with the cash balance of $240 million, implies a value of over $1 billion. . This excludes any value for infrastructure or the $1.6 billion NOL, which could be used to protect taxes in certain circumstances and are increasingly valuable in an environment of rising commodity prices and profitability. And that excludes the potential development value of hundreds of thousands of acres of land, which apparently includes numerous wells that are generating rates of return of over 60% and allowing the company to increase oil production alongside its net cash balance.
As tension mounts, the company’s cash position and profitability also increase. The discount is hard to ignore, and I remain heavily invested in the business at this time. With shares up more than 10x from the sub-$2 share price when I first pointed it out on Seeking Alpha, the company is still misunderstood and still offering substantial upside the price of raw materials at a price lower than that of its peers.