SDR: Termination date contingency pricing

On November 29th, I recommended the Sandridge Mississippian Trust II – ticker SDR – based on the following logic:

Sandridge Energy has a website with a link to an investor website specifically for SDR.  In the S-1/A under SEC filings, the trust was set to last 21 years from its inception in January 2012.  See it at:  http://sandridgesdr.investorhq.businesswire.com/sec-filings

Specifically:  “The trust will dissolve and begin to liquidate on the Termination Date, which is December 31, 2031, and will soon thereafter wind up its affairs and terminate.”

This year is definitely part of the ramping up period, as it’s first 3 payments have been the following:

March 31, 2012   $0.27 per unit

May 31, 2012     $0.497 per unit

September 30, 2012   $.599 per unit

I’m not going to put the entire calculation down – but its the same one as yesterday going 77 lines.  A 9% yield is fair for this type of asset, so that’s what I used.  At $0.5 per quarter, the NPV came out to $18.59 per share.  Assuming a lasting payment of $0.6 per quarter, like the recent payment, the NPV came out to $22.31

With low natural gas prices continuing, the most recent quarterly payment was $0.533 per unit, so it would still fit under my $18.59 price if this continues (I calculated using $0.50 per unit), but recent developments make it prudent to do a contingency analysis for the termination date, so here it is:

Contingency Analysis:  NPV for a sooner termination date
Assuming a payment of $0.50 per unit per quarter requiring a 9% yield
Term Date     NPV
11/29/2031    $18.58
11/29/2026   $16.23
11/29/2021   $12.61
11/29/2016   $7.04
 

Here’s the reason that I bring up this contingency analysis and the reason that SDR has been falling:  It was expected to have close to 80% oil, 20% natural gas.  Instead it has been showing 40% oil, 60% natural gas.  Natural gas is not only much cheaper than oil in the US right now, but the wells also tend to deplete faster than oil wells.  It has been known for these trusts to expire early, as the allocated resources aren’t as good as originally thought.

There is a saying “The best time to buy is when blood is in the streets.”  There is also a saying “Don’t catch a falling knife.”  Time will tell which one applies, but you certainly can’t think of this as a low to moderate risk anymore.

Some analysis here gives hope of better producing wells to come:  http://seekingalpha.com/article/1219421-bakken-update-mississippi-lime-well-design-improvements-are-increasing-estimated-recoveries?source=yahoo

This article is also worth a read:   http://seekingalpha.com/article/1240211-sandridge-beats-estimates-reduces-2013-guidance-and-accelerates-mississippian-drilling?source=yahoo

Another positive on SDR is that its wells are some of the cheapest to develop out there (drilling 7-8,000 feet deep vs 12,000 in the Bakken).  Also, if you believe US natural gas has some upside potential with more NG power plants to avoid pollutants, reduce carbon emissions, and work as a level-load with renewable sources while producing cheap electricity, less NG production as the wells tend to dry out faster than oil and can potentially correct an oversupply faster as well, and the possibility of increased future exports of liquefied NG.

Personally, I have loaded up on way too much of this one already and plan to hold it out.  Plus I’m intrigued by the lower gold prices, and more interested in filling in on those plays for now.  If you haven’t over-accumulated and are interested in this one, however, you could always wait until it stabilizes before jumping… give it a few days of flat or upward trading and then hit the buy button.  I’ll write on gold later – I’m off to socialize with some work friends.

 

John Taylor

 

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About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at gluskinsheff.com. Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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