Avoid These 2 Oil Stocks Like the Plague Even After Their Monster Moves This Week

Markets Motley Fool

Shares of SandRidge Energy (NYSE: SD) and EP Energy (NYSE: EPE) made headlines this week for very different reasons. SandRidge was up more than 13% after two leading shareholders spoke out against its deal to buy rival Bonanza Creek Energy (NYSE: BCEI). Meanwhile, EP Energy slumped more than 23% after offering to exchange some of its existing debt with new borrowings to push out the maturity date.

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While those dramatic moves certainly make investors stop and take notice, the news fueling them didn't alter their prospects. That's why investors should continue to avoid these oil stocks in favor of better alternatives.

Shareholders are standing up

Earlier this month, SandRidge Energy agreed to buy Bonanza Creek Energy in a cash-and-stock deal valuing the target at $746 million. However, SandRidge's shares plunged following the announcement after analysts panned the idea. They don't see the deal as a good use of the company's cheaply trading stock or limited cash resources. That's because there was little overlap between their asset bases, which would limit the ability of the combined entity to cut costs and justify the merger.

SandRidge's stock rebounded this week after two large shareholders voiced their opposition to the deal. On Monday, private investment manager Fir Tree, which owns an 8.3% stake in SandRidge, publicly announced its opposition to the deal with a press release, stating that "the proposed acquisition of Bonanza makes no economic or strategic sense." In the meantime, two days later activist investor Carl Icahn disclosed that he increased his stake in the company to 13.5% and would vote against the Bonanza Creek deal.

One thing Fir Tree pointed out in its statement opposing the transaction is that it "represents a complete reversal of management's post-bankruptcy strategy and reminds us of SandRidge's prior history when this same management team acquired disparate assets and added leverage with reckless abandon." That desire to go down a path that destroyed shareholder value in the past should be reason enough for investors to steer clear of this oil stock, even if a well-known investor like Icahn has been buying.

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An unpopular exchange

On the other end of the spectrum is EP Energy, which, unlike the currently debt-free SandRidge Energy, had roughly $4 billion in debt outstanding at the end of last quarter. For a $4.45 billion company, that's a nearly insurmountable hole.

That said, the company is working to address its financial situation. Its latest step was to offer creditors the opportunity to exchange some of their notes for new ones that mature a few years later. If they agree to this deal, it will buy EP Energy more time to shore up its balance sheet. That said, the market saw this offering as a sign of weakness since it suggests the company can't issue new bonds and refinance this debt. That perceived inability to access outside funding, when combined with its debt-laden balance sheet, is why investors shouldn't touch this oil stock with a 10-foot pole.

A better way to invest in oil

It's entirely possible that investors could make a mint by betting that SandRidge can continue running higher now that shareholders are revolting or that EP Energy can find a solution to dig out of its current mess. However, that's a high-stakes gamble that might not pay off. 

Instead, investors who are looking for an oil stock with upside should consider a top-tier producer like Marathon Oil (NYSE: MRO), which has an excellent management team that has already turned the company around and positioned it to thrive at lower oil prices. In fact, Marathon can increase its production by a 10% to 12% compound annual rate through 2021 and pay its current dividend while living within cash flow at $50 oil. That highly visible upside even if oil prices slip makes Marathon a safer option than either SandRidge or EP Energy, which don't have anywhere near the same clarity on their growth prospects.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.