SandRidge Energy Inc. (SD), Chesapeake Energy Corporation (CHK): Investing in Small Energy Companies Is Dangerous

Page 1 of 2

Modern finance explains that investors are compensated for increased risk with a possible increase in returns. A look at the small upstream firm SandRidge Energy Inc. (NYSE:SD) shows just how true this is. SandRidge Energy Inc. (NYSE:SD)’s CEO, Tom Ward, had a number of side interests that potentially conflicted with SandRidge. The company’s stock price and earnings have behaved poorly and yet, Tom Ward continues to walk away with multi-million dollar salaries.

SD Total Return Price data by YCharts

SandRidge’s economics

In 2012, SandRidge Energy Inc. (NYSE:SD) had production expenses of $14.31 per barrel of oil equivalent (boe). Given that the majority of the firm’s production is highly priced crude oil, there is little reason that the company should be posting such low earnings. It has a five year revenue growth rate 24.71% and yet, it has posted losses in seven of the last 12 quarters. Tom Ward’s $116 million paycheck since 2007 shows where a large portion of these profits have been going. He has also helped saddle the company up with a substantial total debt to equity ratio of 1.69.

SandRidge Energy Inc. (NYSE:SD)

Steep declines in SandRidge’s trusts

SandRidge Energy Inc. (NYSE:SD) has spun off a number of its assets into separate trusts, and investors have been surprised with declining distributions. It is easy to forget that horizontal wells’ production rates can fall off quite steeply. Falling production also hurts SandRidge Energy Inc. (NYSE:SD) as it remains the owner of all of the subordination units of the trusts.

SandRidge Mississippian Trust I (NYSE:SDT) has been around for a little more than a year. In that time, it has seen its dividend fall from $1.07 per share to $0.65 per share. In just seven quarters, its dividend has fallen 40%. Due to overly optimistic projections, SandRidge was recently forced to take a hit as its subordinated units distribution was decreased to $0.50 per unit. Based on current analyst projected 2014 earnings, investors can pick up shares in the trust at forward price to earnings (P/E) ratio of around 7.

With SandRidge drilling more wells SandRidge Mississippian Trust II (NYSE:SDR) has increased its dividend from $0.27 in Q2, 2012 to $0.53 in Q1, 2013. SandRidge is expected to keep drilling new wells for the trust until 2016. Based on 2014 expected earnings, the trust is trading at a forward P/E ratio around 6. The second trust warrants a lower P/E ratio than the first trust, because the second trust’s earnings are 70% derived from cheap natural gas as opposed to 59% for the first trust.

Don’t ignore history

CHK Total Return Price data by YCharts

Chesapeake Energy Corporation (NYSE:CHK) has a similar story to SandRidge. Chesapeake Energy Corporation (NYSE:CHK) had a fiscally liberal CEO who ultimately drove the company to the edge of bankruptcy. Also, the CEO’s ability to purchase partial interests in Chesapeake Energy Corporation (NYSE:CHK)’s wells created questionable conflicts of interest. Chesapeake’s famous purchase of Aubrey McClendon’s personal map collection only made his relation with the company more questionable. Tom Ward worked with Chesapeake Energy Corporation (NYSE:CHK) for an extended period of time before starting SandRidge, and the similarities between the companies should not be too surprising.

Chesapeake Energy Corporation (NYSE:CHK)’s share price has continued to suffer. Low natural gas prices and expensive acreage is not a profitable combination. With a total debt to equity ratio of 1.06, a return on investment (ROI) of (5.2)%, and a profit margin of (11.4)%, there are many better places to park your funds.

Sometimes, bigger is better

Exxon Mobil Corporation (NYSE:XOM) isn’t very attractive and its large size makes replacing reserves difficult, but the company gets the job done. It still benefits from its legacy assets and shows why investors find it easier to trust in large multinationals. The company enjoys a very low cost of production and its refining assets help to even out its earnings. In 2011, its average production costs per boe in the U.S. were $11.14 while its global production costs were only $12.33 per boe.

Page 1 of 2
blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

6 Films About the Financial World You Need To Watch (While “The Wolf” is Not Around)

Warren Buffett and Billionaires Are Crazy About These 7 Stocks

The Top 10 States With Fastest Internet Speeds

10 Best Places to Visit in USA in August

Top 10 Cities to Visit Before You Die

Top 10 Genetically Modified Food In the US

15 Highest Grossing Movies Opening Weekend

5 Best Poker Books For Beginners

10 Strategies Hedge Funds Use to Make Huge Returns

Top 10 Fast Food Franchises to Buy

10 Best Places to Visit in Canada

Best Summer Jobs for Teachers

10 Youngest Hedge Fund Billionaires

Top 10 One Hit Wonders of the 90s

Fastest Growing Cities In America

Top 10 U.S. Cities for Freelancers

Top 9 Most Popular Free iPhone Apps

Top 10 Least Expensive Private Business Schools in the US

Top 15 Most Expensive Countries in the World – 2014

Top Businesses to Invest In

Top 5 Things You Might Be Doing Wrong With Your Business

Top 5 Strategic Technology Trends in 2014

Top Rags to Riches Stories

Parenting Behavior That Promotes Future Leaders

Top 5 Mistakes Made by Small Businesses

Top 5 Most Common and Potentially Devastating Financial Blunders

Top 5 Highest Paying Jobs for Web Designers

Top 6 Most Respected Professions that Also Pay Well

Top 5 Pitfalls Investors Should Avoid

Top 6 Lawyers and Policy Makers Under 30

Top 6 New Year’s Resolutions for Entrepreneurs

Top 7 Locations to Check in on Facebook

Top 5 Mistakes made by Rookie eBay Sellers

Top 7 eBook Publishers in 2013

Top 6 Health Industry Trends in 2014

5 Lessons for Entrepreneurs from Seth Godin

Top 5 Success Tips from Jordan Belfort – the Wolf of Wall Street

Best Master’s in Finance Degree Programs

Top 6 Earning Celebrities Over 50

The most expensive sports to play

Top 7 Earning Celebrities Under 25

Best 7 Online Courses to Take: Free Finance MOOCs

Top 6 Bad Habits that Promote Failure

20 Most Valuable Soccer Teams in the World in 2013

12 Most Expensive Countries for Foreign Students

Top 30 Most Influential Women in the World

Top 20 Most Expensive New Year Eve Shows

Top 5 Best Vocational Careers

Top 10 Jobs for 2014 by Salary Gain (Predictions)

Top 5 Digital Trends for 2014

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!