Image source: Emerge Energy Services.
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The oil crash has proven devastating to frack sand producersU.S. Silica Holdings(NYSE: SLCA), Emerge Energy Services (NYSE: EMES), Hi-Crush Partners (NYSE: HCLP), and Fairmount Santrol (NYSE: FMSA).With all four stocks tradingnear all-time lows, investors may be wondering whether or not it's worth continuing to hold or even open or add to positions at these fire-sale prices.
So let's look at three key elements based on management comments from the latest earnings conference call, about what to expect in 2016 that maymean the difference between a once-in-a-generation long-term investing opportunity, or a hopeless value trap.
Further industry consolidation is likely
Sources: earnings transcripts, earning releases, 10-Ks, author calculations.
As you can see, over the past year, America's four largest frack sand producers have seentheir market share increase as smaller, less capitalized competitors have eithergone out of business, or been unable to compete with theirlarger and better organized transportation logistics networks. This is a trend that Fairmount Santrol thinks is likely to continue and result in more dominant and profitable companies once crude recovers.
Even Emerge Energy, whose debt-heavy balance sheet recently forced a renegotiation of its debt agreements with creditors, has stated that creditors remain supportive of the MLP acquiring smaller, distressed competitors, as long as additional debt isn't required to finance such deals.
Meanwhile, U.S. Silica management has stated that buying up weaker competitors is the company's top priority when it comes to allocating increasingly scarce capital.
Hi-Crush Partners is taking a different approach to M&A, focusing not on increasing capacity but on expanding its already vast distribution network. This is because the cost of producing sand is ultimately only about 25% of the ultimate cost at the wellhead, so the sand producer with the most efficient transportation network has a competitive advantage that can increasemarket share.
Balance sheet strength is more important than ever
|Company||Cash||Debt||Current (Liquidity) Ratio||TTM EBITDA/TTM Interest Cost|
|U.S. Silica||$300 million||$493 million||4.9||5.5|
|Hi-Crush Partners||$5 million||$252 million||2.9||3.7|
|Emerge Energy Services||$6 million||$273 million||2.6||5.7|
|Fairmount Santrol||$180 million||$1.241 billion||3.9||3.5|
Data sources: Earnings releases, Morningstar.com.
As you can see, there are large differences in the strength of the balance sheets between these companies and MLPs. This is important for investors to keep in mind, because in an age of much cheaper oil, more leveraged sand producers such as Hi-Crush, Emerge Energy, and Fairmount are at the mercy of their creditors. In fact, all threerecently had to amend their creditfacilitiesbecause plummeting EBITDA was forcing them into violation of their existing debt covenants, especially those limiting their leverage ratios (debt/EBITDA).
Fairmount's amended agreement raised its allowable leverage ratio to 6.5 throughQ1 of 2017while those of Emerge and Hi-Crush waive the debt covenant ratios entirely through mid-2018 and mid-2017, respectively.
However, though granting both MLPs some breathing room, they also came with harsh stipulations. Not onlydoes each MLP face a diminished borrowing base andhigher interest rates,but in Emerge Energy's case, creditors areseverely curtailingthe MLP's ability to invest in further expansion into 2019.
It also limits Emerge from acquisitions that require additional debt, aconstraint that cash-rich U.S. Silica doesn't face, and thus gives America's largest frack sand company a chance to potentially grow its market sharegreater than its more indebted peers.
Recovery may not happen in 2016
The combination of rising global demand for oil and falling non-OPEC productionhas the IEA predictingcrude'ssupply glutwill shrink by 1.8 million barrels per day, or bpd.
However, with Iran promising to increase production by 1.5 million barrels bpd thanks to the ending of nuclear sanctions, as well as global oil stockpiles at record levels, increasing oil prices in 2016 are far from guaranteed.
Bottom line:No one can predict when oil prices will finally turn around, or by how much. While a sharp recovery in 2016 is possible, investors need to be aware that the investment thesis for these four companies is a multi-year story. When it comes to 2016, such expectations are purely speculative.
The article 3 Things All Frack Sand Investors Need to Know About 2016 originally appeared on Fool.com.
Adam Galas owns units in Emerge Energy Services and Hi-Crush Partners. The Motley Fool recommends U.S. Silica Holdings. 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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