13 January 2015
HY Corporate Credit
Energy
Sandridge Energy
Relative Value
As a single-asset company with modest economics, SandRidge (SD) is
relatively more vulnerable to the new, significantly weaker commodity price
landscape. Notwithstanding the high-grading and the substantial operational
improvements across its Mississippian acreage over the past two years, the
company is likely to struggle to build a sustainable business over the long term
given the weak outlook for oil prices. DB equity research sees the
Mississippian Lime achieving a 10% IRR at $80/bbl oil, one of the most
challenged plays in the US. The structural funding gap problem - the intensity
of which had been steadily receding in recent quarters due to solid operational
performance - is now front and center. Despite a sharp ramp down in its
capital program - we expect annual capex to average $1 billion over the next
two years (versus $1.6 billion in FY 14E) - we see the company burning $1.2
billion of cash through FY 16, exhausting most of its current liquidity of 81.3
billion. More worryingly, we see outlook for continued cash burn indefinitely
beyond FY 16 even in a maintenance capex mode. We see annual run-rate
EBITDA of -$710 million at $65 oil/$3.75 gas. Given annual interest obligation
of close to $300 million, the company will clearly be unable to meet
maintenance capex of, say, $500-700 million and remain FCF neutral This
situation would be further aggravated in a downside scenario of $60 oil/$3.5
gas with EBITDA dropping to $560 million. In short, the Mississippian acreage
is not well suited for a low commodity price environment. especially as a core
play for a company as financially leveraged like SD. Further, the option of
augmenting its liquidity via asset divestitures, which appeared to be a viable
one just a few months back, is now all but gone. Its midstream infrastructure
in the Mississippian play, which might have fetched a valuation of up to $1
billion earlier will now be worth much less, and on a partial monetization, could
receive maybe 5200-$250 million. This overlooks the difficulty in even
attracting buyers given questions over long term sustainability of play
economics. The value of its stake in upstream trust subsidiaries has also taken
a severe beating in recent months and is now worth a little over $100 million.
While we acknowledge that the recent resolution to the financial filings is a
positive, the viability of the Mississippian play is still a major concern for the
market as evidenced by the trading levels of other HY issuers with core
positions in that play. Midstates Petroleum (MPO, not covered) is a relatively
smaller Mississippian comp with a fraction of the liquidity of SD and about
1.5x turns more leverage (6.5x in 2016 Bloomberg consensus) - it trades at
about 2x the spread of SD (51W: -2500 bps area). That said, looking at
SandRidge, we don't see any visible catalysts on the horizon. Technically
speaking, the credit is up roughly 10 points from its mid-December lows
(bonds now in the 66-67 area. YTVV: 5-18%) leaving us to believe that
upside/downside is skewed to the downside as we enter the seasonally weak
1H. Further, we think current trading levels already have an expectation of
lower announced 2015 capex levels built in. With that said, we are moving to
a SELL from a HOLD rating on the name as we believe one could see more
attractive entry points in the name going forward. Upside includes better well
cost reductions and higher type curves and lower than expected FCF burn.
Page 112 Deutsche Sank Securities Inc.
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