The oil crash has hit oil companies hard, but it is also punishing oil-service stocks and frack sand suppliers such as US Silica Holdings , Emerge Energy Services , and Hi-Crush Partners . To see what's in store for these stocks in 2015 let's look at three important trends the companies' management teams highlighted during their latest earnings conference calls: margin pressure, a potential demand recovery, and distribution safety.
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Margins taking a beating due to falling sand prices
"We've temporarily reduced prices and taken additional costs out of the supply chain in exchange for extending contract terms or increasing sales volumes. We also expect to continue to take share and to be positioned to emerge even stronger from the downturn. For example, recently working with a very large customer to help them reduce their input costs enabled us to capture substantial new volumes and earn the commitment from them to be one of their top suppliers going forward as they work to significantly consolidate their sand spend." -- Bryan Shinn, US Silica CEO.
Despite having substantial contracts in place that ensure certain volumes and sand prices, frack sand suppliers are working to help drillers through this difficult market environment in which overall frack sand demand has fallen by 30% to 40%. Thismeans accepting lower prices -- on the order of 20% to 25%-- than is contractually required in exchange for higher volumes, longer contracts, or both.
However, Emerge Energy pointed out that not all customers are willing to meet frack sand suppliers halfway regarding contract adjustments, which raises the risk of contract cancellations or breaches.Still, thanks to renegotiations with customers, 66% of Emerge's sand prices are now indexed to West Texas Intermediate crude, meaning the recent price rally should help boost margins going forward if the recovery holds.
Demand recovery is on the horizon
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"Talking to our customers as well as E&P companies in the basins where our product is used many can sense that a recovery could be around the corner. However, the exact timing is hard to predict" -- Ted Beneski, Emerge Energy Services chairman.
The big caveat here, of course, is that the timing of a potential recovery in drilling is uncertain and tied to highly volatile oil prices. However, all three sand producers are optimistic about three major demand growth catalysts.
The first is the large number of drilled but uncompleted wells, which independent research analysts believe number roughly 3,000 but Hi-Crush estimates closer to 4,000 to 5,000.
US Silica believes a recovery in oil prices could spur the rapid completion of these wells and trigger a strong demand increase in late 2015 and early 2016. This is particularly true if Hi-Crush co-CEO James Whipkey is correct that only 25% of oil producers are currently using the most modern, sand-intensive fracking techniques.
Given that more intensive use of sand is one of the best ways to increase returns per well, the average sand use per well should increase in the next few years.
Finally, as Hi-Crush pointed out, Schlumberger and Halliburton -- the world's two largest oil-service companies --have expressed more interest in re-fracking older wells.
Better yet for these sand producers, these oil-service giants are recommending customers use high-grade frack sand instead of more expensive ceramics or resin-coated sand. In a difficult market environment that advice could help frack sand steal market share from these sand alternatives. As Emerge pointed out, it can adjust the grade of frack sand -- smaller grains are increasingly in demand -- by adjusting how deep it mines.
Short-term payouts looking shaky
"Distributable cash flow attributable to the limited partners, after allocation to the incentive distribution rights, was $25 million for the quarter, generating a coverage ratio of one time the distribution to be paid to the common and subordinated unit holders." -- Laura Fulton, CFO, Hi-Crush Partners.
After Emerge Energy's 29% distribution cut this quarter and 47% reduction in 2015 distribution guidance -- done to ensure compliance with debt covenants -- Hi-Crush investors are likely nervous about the safety of their own 8.6% yield.
While Hi-Crush isn't a variable pay master limited partnership like Emerge -- meaning it can save excess discounted cash flow to smooth out distribution payments whereas Emerge must payout all DCF each quarter -- in the last two quarters Hi-Crush's coverage ratio has declined by 47%, from 1.87 to just 1. So while the current payout is safe, if industry conditions get any worse Hi-Crush investors should be prepared for a potential payout cut.
Takeaway: industry under stress but recovery possibly on the horizon
Despite the recent drop in frack sand demand, prices, and margins, the industry's long-term outlook remains bright. Investors who are brave enough to buy now and remain patient while riding out the storm should be rewarded when oil prices finally recover.
The article Oil Dividend Stocks: 3 Facts All Frack Sand Investors Need to Know originally appeared on Fool.com.
Adam Galasowns units of Emerge Energy Services andleadsThe Grand Adventuredividend project, which recommends Emerge Energy Services and US Silica.The Motley Fool recommends Halliburton and U.S. Silica Holdings. The Motley Fool owns shares of Halliburton. 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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