Prem Watsa Keeps Buying Up SandRidge
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It’s been a tough year for natural gas businesses. Chesapeake Energy (NYSE: CHK), for example, is down 29% since the beginning of 2012; natural gas prices have dropped, concerns over poor corporate governance arose last spring, and the company has had to plan to sell off some of its assets to raise cash. A similar controversy is currently playing out at SandRidge (NYSE: SD), as TPG-Axon Capital Management has launched an activist campaign against the company’s CEO and has nominated a shadow Board of Directors. Mount Kellett Capital Management also owns a large stake in the company (find more stocks Mount Kellett owns) and has been dissatisfied with operations at SandRidge. This stock is down 23% since the start of the year.
Prem Watsa, a value investor known as “the Warren Buffett of Canada” for his management of holding company Fairfax Financial, however, thinks that everything’s fine at SandRidge. In November he called controversial CEO Tom Ward “one of the best operators in the business” in an interview with Bloomberg News. Now Fairfax- which is another major holder of SandRidge- has increased its stake further, buying about 5 million shares of the stock in late December for a total of about 30 million shares. According to our database of 13F filings, the holding company had only owned 4.4 million shares at the beginning of October (see Watsa's other stock picks). The battle for control of SandRidge could get nasty.
In the third quarter of 2012, revenue was up 46% from the same period in 2011. However, a large loss on derivative contracts singlehandedly gave SandRidge Energy negative operating income. It looks to us that without that loss- and, logically, without the large gain on derivative contracts in Q3 2011- that operating income was up nicely from a year earlier despite disadvantageous changes in natural gas prices. Cash flow from operations was about $580 million in the first nine months of 2012; the company used $2 billion of cash in investing activities, primarily capital expenditures, but the cash hoard increased by nearly half a billion dollars as SandRidge managed to make large borrowings and issue royalty trust units.
Wall Street analysts expect SandRidge Energy to be unprofitable in 2013. We’ve noted the activities of Mount Kellett and TPG-Axon, who are bullish primarily because they believe management can be replaced, and a number of other traders seem to have gone to straight-up bearishness on the company as 18% of the outstanding shares are held short.
Chesapeake is the closest peer for SandRidge. It trades at 12 times forward earnings estimates, as billionaire Carl Icahn’s involvement in the stock served as a signal that the company would be able to raise sufficient cash and stabilize its financial position. Read our recent analysis of Chesapeake and check out Icahn's favorite stocks. We can also compare the company to Devon Energy (NYSE: DVN), Apache Corporation (NYSE: APA), and EOG Resources (NYSE: EOG), though these peers tend to have considerable production of oil as well as natural gas. There is a wide range of forward P/E multiples here, with Apache as low as 8 times consensus earnings for 2013 while EOG carries a forward P/E of 19. However, these valuations generally reflect current business conditions: in its most recent quarter, Apache’s net income was down 82% from the same period in the previous year. EOG also had lower income, but sales were up strongly and analyst estimates for the next several years actually imply a five-year PEG ratio of 1. Devon is about in the middle of these two peers at 12 times forward earnings estimates, but that assumes a much better performance in 2013 as the trailing P/E is a considerably higher 32. None of these three companies really look like good buys, as they are dependent on doing much better this year than they have this year.
Activism at SandRidge, including a possible sale of the company, could certainly serve as a catalyst. However, we don’t like the forecast of net losses for next year- especially since analysts seem to be optimistic about the industry in general, judging by the high earnings estimates and Chesapeake and other peers. This doesn’t seem like a good time to buy SandRidge.
This article is written by Matt Doiron and edited by Meena Krishnamsetty. Meena has a long position in CHK. The Motley Fool owns shares of Apache and Devon Energy and has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, long JAN 2014 $30.00 calls on Chesapeake Energy, and short JAN 2014 $15.00 puts on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!