Billionaire Leon Cooperman Still Likes This Energy Stock

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

At the Delivering Alpha conference on July 17, billionaire Leon Cooperman of Omega Advisors listed SandRidge Energy (NYSE: SD) as a potential turnaround and one of his top picks. At Insider Monkey, we track quarterly 13F filings from Omega and hundreds of other hedge funds as part of our work researching investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year) and can see from our database that the fund owned about 27 million shares of SandRidge as of the end of March (check out more stocks Omega owned).

A closer look at the company

SandRidge had encountered trouble late in 2012 as activist investors attacked the company’s founder and then-CEO Tom Ward for poor management decisions, high compensation, and (in some cases) less than above board business activities. At the same time, SandRidge was struggling after overinvesting in natural gas production and being caught off guard as product prices remained low. Indeed, production volumes in MBoe terms grew by 49% in the first quarter of 2013 versus a year earlier. However, revenue was up “only” 34% on these production numbers and even after adding back a large loss on sale of SandRidge’s assets operating income only came out to about $40 million, with the company then being pulled into the red in adjusted terms by interest expense. The stock is down 24% in the last year, while market indices have risen.

Wall Street analysts are predicting that SandRidge’s troubles will continue in the near to medium term future, with net losses being forecast for this year and for 2014. It is probably the case that the company will struggle at least as long as natural gas prices remain low; in theory, demand should rise over the next few years as more energy users adapt to use natural gas and various market players build out enough infrastructure to export it (U.S. natural gas prices are much lower than in most of the rest of the world due to a glut of domestic production, and this cheap gas would be eagerly snapped up in other countries.)

It should be noted that, in statistical terms, movements in SandRidge’s stock price tend to be highly correlated to those of market indices, as can be seen by the beta of 3.5. In addition to Omega’s interest, Fairfax Financial- which is managed by value investor Prem Watsa- was a major shareholder in SandRidge with more than 32 million shares in its portfolio (find Watsa's favorite stocks.)

Comparing SandRidge to its peers

Chesapeake (NYSE: CHK) is another oil and gas company which has been seeing activism and management changes in recent years in response to its business’s troubles. It has also been struggling with its business recently, but quarterly numbers show rising adjusted EPS and the sell-side is forecasting $2.04 per share in earnings in 2014, making for a forward earnings multiple of 11.

Of course, Chesapeake is also dependent on commodity prices over the long run, and so if the natural gas market continues to be weak, its financial performance will continue to lag as well. It is interesting, however, that the sell-side is predicting a stronger improvement for Chesapeake next year than it is for SandRidge; this may be due to the fact that Chesapeake has fortified its balance sheet by selling off some of its shale assets.

SandRidge can also be compared to Devon Energy (NYSE: DVN). Devon is expected to dramatically increase its earnings per share over the next year and a half, and is valued at 11 times forward earnings estimates. However, investors should be quite concerned about how the company has been doing recently: During Q1, product revenue was down 6% from levels a year ago, and operating profits were essentially zero after adding back impairment and restructuring charges. It’s not necessarily the case that Devon will continue to struggle, particularly if the pricing situation does improve (three-quarters of its production by BoE equivalent is natural gas and natural gas liquids) but it seems speculative to buy the stock solely on hopes for future improvement.

Conclusion

SandRidge is a possible turnaround, but investors should be aware that analysts are expecting net losses next year even as their forecasts for many of its peers are fairly rosy. It certainly seems that those investors who want to make a somewhat risky investment in a stock tied to natural gas prices might be better served by going long Chesapeake at this time, and should at least wait for SandRidge to start showing operating profits and improvements in its business given that it seems to be dependent on outperforming sell-side forecasts for 2014.

 

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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 January 2014 $20 calls on Chesapeake Energy, long January 2014 $30 calls on Chesapeake Energy, and short January 2014 $15 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!

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