3 Dangerous Oil Stocks

Image source: InterOil investor presentation

No one would say that investing in energy today is without risk. The collapse of oil prices over the past several months has brought the long term viability of many companies into question. There are, of course, the companies that we all expect to survive this downturn just like they have every other market downturn over the past 150 years. On the other hand, there is also the subset of companies that look extremely dangerous right now.

So we asked three of our energy contributors to name a company that they think is radioactive right now and that investors should tread very lightly around. Here's what they had to say.

Bob Ciura:The crash in oil prices is devastating upstream oil and gas MLPs likeBreitburn Energy Partners. Breitburn has had an awful year, as its unit price is down 86% just in the past 12 months. After such a steep decline, bargain hunters may find Breitburn attractive, as the stock currently offers a tantalizing 16% distribution yield. However, the reason I view Breitburn as a dangerous stock is that that yield might not last long.

Breitburn already has two distribution cuts under its belt in the past year. Now, the company is confident it can fund its $0.50-per-unit annualized distribution with underlying cash flow, as a result of its hedging practices and expense reductions. Breitburn's total production is 77% hedged for the remainder of 2015, and 65% hedged for next year. And last quarter it reduced lease operating expenses by 6% per barrel from the previous quarter.

The reason I'm suspicious of Breitburn is that one of its closest peers,LINN Energy, said the same thing about its own distribution, only to announce it would suspend its payout entirely after the third quarter. In the investing world, when something looks too good to be true, it usually is. With oil stuck at $43 per barrel, I'm very wary of Breitburn's 16% yield, even though Breitburn's distribution coverage ratio hit 2.16 times last quarter.

A sky-high yield looks enticing, but it's only there until it isn't. While Breitburn's distribution remains intact for now, based on what is happening to its peers, another cut or suspension can't be ruled out entirely. Investors should proceed carefully before buying Breitburn for its huge yield.

Tyler Crowe: The wildcatters of the American oil business have always taken a go-big-or-go-broke approach to finding oil. The solution to problems has always been to just go out to the field and find more oil to produce when times get tough. In some ways, Halcon Resources has been a reflection of that wildcatter mentality, but in today's oil market it is not doing so great.

The biggest case against Halcon right now, of course, is its mountainous debt load. Even ignoring something like debt-to-capital right now because the market value of its stock has been hammered down more than 85% over the past year or so, the company's total debt is equivalent to 78% of its total assets. What is even worse, though, is that the company's oil and gas property value is based on oil and gas prices of $95 per barrel and $4.35 per thousand cubic feet, respectively. When those property values are reevaluated based on more recent oil and gas prices, there is a very good chance that its total debt outstanding will be greater than its total assets. That's basically the same as being underwater on your mortgage.

The financiers that are loaning to Halcon aren't exactly lending with great confidence, either. A few months prior, the company issued $700 million second-lien notes -- which, going back to the housing analogy, is like taking a second mortgage. These are not the kinds of moves that a company on solid financial footing needs to make.

The one thing in Halcon's favor is that it can hide behind a shield of hedging contracts for the rest of the year and into 2016. By producing only a marginal amount more than what its hedge book has protected and slashing spending to only stay at those levels, it is possible that the company could keep the lights on for a while longer. But that doesn't preclude the fact that the company's spending is still in excess of its ability to bring cash in the door and it will be forced to raise capital in some way. The window for debt financing is getting very small, so chances are, it will need to raise that money in some other way.

Matt DiLallo: I have basically lost all confidence inSandRidge Energy(NYSE: SD). In a lot of ways it's Halcon Resources all over again, as it has a mountain of debt and a shrinking asset base with which to repay it. Furthermore, like Halcon, it too just took on second-lien debt, piling another $1.25 billion onto its balance sheet and leaving it with another problem to solve.

One of the final straws is that CFO Eddie LeBlanc recently announced his retirement after just two years on the job. While the company promptly named a replacement, it seemed like odd timing, as if he didn't want to go down with the ship after saddling it with even more debt. Meanwhile, newly named CFO Julian Bott might have three decades of experience in both the oil and gas industry and investment banking, but his resume doesn't suggest he can pull SandRidge out of the pit it dug for itself, as he's not a turnaround expert.

Unless oil really rebounds sharply over the next year, there's a very real possibility that SandRidge Energy will be joining Halcon Resources in bankruptcy. Time is really ticking away as it continues to burn through its oil hedges, which once gone will further crimp already weak cash flow. That will impact not onlySandRidge's ability to simply maintain production, but also its debt payments. This has become a dangerous oil stock with a very binary outcome of either bankruptcy or meager survival.

The article 3 Dangerous Oil Stocks originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. Matt DiLalloand Tyler Croweown shares of Linn Energy, LLC, and Matt owns shares of SandRidge Energy. The Motley Fool recommends BreitBurn Energy Partners. 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.

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