Frac sand producers such as U.S. Silica , Hi-Crush Partners , and Emerge Energy Services , experienced incredible growth in 2014, reporting record growth in sales and earnings. However, with oil prices now at six year lows investor fears and uncertainty have sent share prices crashing by as much as 64% in the last six months.
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I'd like to take a look at four facts highlighted by US Silica's and Hi-Crush partners managements in their latest quarterly conference call -- a valuable but underutilized investing tool -- so that you can see get a better idea of whether these companies and MLPs now represent great long-term income opportunities or merely value traps.
Better fracking techniques require more sand
Shinn is referring to the fact that, over the past four years, the amount of frac sand used per well has more than doubled, from 2,500 tons per well to 5,000 tons with some wells using as much as 8,000 tons. More importantly, according to Schinn, this is a long-term trend that will continue.
Higher sand demand per well might help decrease the coming pain by lowering break even costs of drilling
The reason for US Silica's optimism is because the new fracking techniques -- such as an increased number of fracking stages --that have lead to productivity per rig increasing as much as fivefold over the past four years. This has lowered the break even cost of U.S. shale oil production and allows shale producers to hold out longer in their current price war with OPEC. For example, increased use of horizontal fracking with more frac stages has lowered the break even price of oil in Texas's Eagle Ford shale to just $45 according toRusty Braziel, president of the oil industry research firm RBN Energy.
Supply growth creates uncertainty about long-term frac-sand pricing
This quote highlights the fact that U.S. Silica remains bullish on the long-term demand for frac sand, however, should oil prices remain low for several years then the entire industry might face an oversupply problem that might send the long-term price of frac sand crashing.
U.S. Silica, Hi-Crush Partners, and Emerge Energy have 70%,88%,and 87%of their production currently under long-term contracts, which protect their cash flows for up to 4.2 years. However, as those contracts end, lower frac sand prices might result in sales, earnings, and distribution growth greatly slowing or even turning negative in the years to come.
Strong Coverage Ratios and Balance Sheets mean safer payouts and chances for potentialopportunisticacquisitions
Hi-Crush and Emerge Energy Services are fast growing MLPs with generous yields of 7.8% and 10.8%, respectively. Given likely deteriorating market conditions income investors probably want to know two things. First, how safe are the current payouts, and second that these MLPs will be able to pay their high yields without sacrificing growth capital that's needed to expand production and transportation capacity.
As this quote indicates, Hi-Crush's distribution is well covered by its distributable cash flow or DCF which is well protected by its long-term, take or pay, contracts. While it's always possible that oil service companies might breech these contracts if oil prices decline or remain suppressed for several years, at least for now the payout appears safe.
Emerge Energy Services, on the other hand, is a variable paying MLP that pays out almost 100% of its DCF each quarter -- likely why market is offering a substantially larger yield relative to Hi-Crush.Thus while Emerge Energy would be the first frac sand MLP to, given its growing capacity and strong contract backlog, I think that the chances of the the distribution amount decreasing are slim, at least for 2015.
Finally, the strong balance sheets and available liquidity US Silica, Hi-Crush, and Emerge Energy have available means that, should the frac sand industry experience severe distress these three giants of the industry would be the best positioned to step in and acquire additional assets at fire sale prices. This would likely mean larger market share in the long-term, and faster distribution growth when oil prices finally recovered to sustainable levels.
Takeaway: 2015 may see earnings fall but oil crash is likely to create great long-term buyingopportunityFrac sand suppliers such as U.S. Silica, Hi-Crush Partners, and Emerge Energy Services are unlikely to grow sales and earnings in 2015 due to the oil crash. However, their long-term contracts and the fact that greater use of frac sand is one way for oil and gas companies to maximize productivity from each well means that demand declines might prove smaller than those of other oil services companies. Thus I would advise potential and current income investors to look at any sharp share price declines in 2015 as a potential long-term buying opportunity. However, due to the uncertainty about how long oil prices may remain suppressed, any such investments should only be made as part of a well diversified portfolio.
The article After a Record Smashing Quarter 4 Things All Dividend Frac Sand Investors Need to Know originally appeared on Fool.com.
Adam Galashas no position in any stocks mentioned however he leadsThe Grand Adventuredividend project which owns US Silica and Emerge Energy Services in several portfolios.The Motley Fool has no position in any of the stocks mentioned. 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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