Over the past year, SandRidge Energy's (NYSE: SD) stock has been pummeled: It's down 73%. One would think the worst is over, and that there isn't a lot of downside ahead. However, that's not the view of short-sellers, as they've actually increased their short-selling bet on the stock over the past month.
Piling on this short
As of the most recently available data, nearly 69 million shares of SandRidge's stock have been sold short. That represents 17% of its public float and is higher than previous months, as investors increased their short bet by 3.5 million in just the past month. This shows investors are growing increasingly worried about SandRidge's outlook, despite the fact that oil prices are improving.
What's interesting is that this increase in shares shorted is coming at a time when short-sellers haven't had much to celebrate -- the stock has been surging. As we see in the following chart, the stock is now up nearly 46% over the past three months, thanks in part to a nearly 25% rally in oil prices off the bottom.
Short-sellers, however, simply don't see what all the fuss is about as they don't see any evidence that SandRidge has really addressed any of its longer-term issues.
What short-sellers see
Unless oil prices vastly improve, SandRidge Energy faces two very grave issues. First, it simply can't grow its production at current oil prices, and worse yet, the company's debt is about a billion dollars too high for the current oil price. While the company says it's working on addressing both issues, short-sellers are betting it won't be able to fix either, which will send its stock even lower.
The most concerning problem in the near term is the fact that SandRidge Energy is outspending its cash flow again in 2015. The problem is that this outspend is only driving 6% production growth, which is well off from its previous expectation of a 20%-25% growth rate. Further, the company plans to sell assets to bridge the gap, but that's just a stop-gap measure, as the funding gap will only widen next year if oil prices don't improve. This is because a large portion of its 2015 cash flow is backstopped by its oil and gas hedges. As those roll off, SandRidge's cash flow will suffer. That suggests the company would have to cut its capex again next year, which could lead to a meaningful decline in its production.
The company doesn't really have a choice but to cut its capex next year, as outspending will lead to the company piling on more debt. That's a problem, as CEO James Bennett has already admitted that if the current oil price is the new normal, then SandRidge would "probably want to remove $1 billion of debt from the balance sheet." So, using debt to fund its funding gap just to keep production flat really isn't an option, as the company needs its debt level to fall, not increase.
Short-sellers aren't so sure it will be able to address its debt until oil prices are meaningfully higher, and it is anyone's guess when, or if, that will happen.
Investor takeaway
Short-sellers don't like what they're seeing from SandRidge Energy, which is why they're selling more shares short. Some see the recent rally in the stock as an opportunity to profit from the next leg down, while others don't expect the company to overcome its longer-term issues before oil prices rebound.
That said, if oil prices do rebound meaningfully, these short-sellers could be scorched as a return to triple-digit oil could send SandRidge's stock back into the mid-single digits.
