Sandridge Energy (SD) has more than doubled over the past two months. This performance is largely due to three factors: strong gains for oil and natural gas prices, the company raising money at favorable terms, and asset sales which have raised more money than expected.
From mid-March to early-November, the energy complex had been gradually recovering from its Covid-19 induced lows, yet it was underperforming the broader market. However, the calculus changed with the vaccine news, as oversold sectors grabbed the baton and have led the market higher.
Rebound in Energy
Energy stocks have been underperformers since late-2018 due to slowing global growth which impacted demand. Additionally, supply was plentiful especially with the shale patch helping the US go from a net importer of oil to a net exporter.
As a result, oil prices trended lower from above $70 in late-2018 to $63 at the start of 2020. Oil’s losses intensified due to the inability of OPEC countries to agree on production cuts. Saudi Arabia decided to punish oil-producing countries by increasing their production. This caused another drop in oil prices which intensified with the coronavirus and the ensuing shutdowns.
Eventually, it led to a sharp decline in demand resulting in a record build in oil inventories. The situation also climaxed with the unprecedented circumstance of the front-month oil contract going negative due to excess oil supplies relative to demand. However, the situation forced steep production cuts. Additionally, economic activity has rebounded.
Now, the vaccine news is a paradigm shift. Until then, the consensus was that the coronavirus would be an issue until 2022. However, it now seems that the world should return to normal by Q2 of next year.
One consequence of the world returning to normal is a sharp uptick in energy demand as people will resume traveling, going back to the office, and industrial activity will return to 2019 levels all over the world. However, oil production will lag in returning to previous levels. Ironically, the energy market’s supply-and-demand equation could be the inverse of what it was at the beginning of the year.
The turnaround in energy stocks has many parallels to rebounds in other sectors out of deeply oversold states such as financial stocks in 2009 or steel stocks in 2003. One observation is that often the companies with the best performance are those that are the most leveraged and saw the worst performance during the decline. This is because they have the most room for improvement, high levels of short interest, and bearish sentiment.
Sandridge (SD) is a poster child of this phenomenon. It dropped from above $10 in October 2018 to $0.70 at the March lows. Since then, the stock is up nearly five-fold.
Asset Sales and Investment
Even with the improvement in energy prices, SD is in a tough situation with high levels of debt. In turn, the company has been selling assets. One reason that the stock has been so strong in the past couple of months is that surprisingly, these assets are getting a healthy premium which indicates that SD’s stock price was undervalued.
For example, the company recently sold about 10% of its production and reserves for a price that was equivalent to 42% of its market cap.
Another catalyst for SD was a low-interest loan from Carl Icahn for $30 million at terms that were much more generous than its current loan terms. Icahn’s support for the company is a vote of confidence as he owns 13% of the company which was purchased in 2018 and 2019 at a much higher price.
While the easy gains for Sandridge are in the rear-view mirror, the stock has more upside if oil and natural gas prices keep moving higher.
I believe that this is likely for both commodities. For natural gas, prices have remained depressed since 2008. In part, this was due to increasing amounts of oil production in the shale patch, and natural gas was a byproduct of this process. There was so much natural gas that large quantities were burned at the source.
Now, shale production is declining, and rig counts have plummeted. Given the losses incurred by investors, it’s unlikely to immediately rebound until prices materially climb higher and remain there for an extended period. Low natural gas prices for over a decade means that CAPEX in the sector has been low for quite some time. Therefore, conditions are in place for a long-awaited natural gas bull market.
In terms of oil, similar dynamics are in place. Currently, production remains low, while demand is returning as economic activity gradually picks up. We are working through oil inventories and could see a major snapback in oil demand as pent-up demand is unleashed for travel once the vaccine becomes widely distributed.
Sandridge’s POWR Ratings are constructive as well. The company is rated a Buy. It has an “A” for Trade Grade and Peer Grade. Among Energy – Drilling stocks, it’s ranked #2 out of 20.
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SD shares were trading at $3.25 per share on Wednesday morning, down $0.24 (-6.88%). Year-to-date, SD has declined -23.35%, versus a 16.46% rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of POWR Growth newsletter. Learn more about Jaimini’s background, along with links to his most recent articles. More...
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