Energy Company Finds A Fortune In The Sandbox

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If there's one thing the Earth is not short of, it's sand. Anyone who's ever walked on a beach or driven across a desert can tell you that.

What you might not know is that not all sand is created equal.

That white, powdery stuff you toss in your kid's sandbox might be good for playing around in, but there's a reason you can get 50 pounds of it for a few bucks at your local hardware store. It's just regular, run-of-the-mill sand.

Frac sand, though, that's a different story. This is a durable, high-purity quartz sand with very round grains that, if it were human, would probably look down its nose at everyone else.

Emerge Energy Services ( EMES ) knows all about the high perch frac sand occupies in the sand world. The company, which operates as a limited partnership, is one of the leading miners and suppliers of frac sand used in the hydraulic fracturing process that produces oil and gas.

The rise of "fracking" in North American shale oil formations in recent years has led to an explosion in demand for frac sand. It has also driven strong sales and earnings gains at Emerge Energy.

Emerge operates two different businesses. Its sand subsidiary produces silica sand for the hydraulic fracturing of oil and gas wells. This side of the business operates sand facilities in New Auburn, Wis.; Barron County, Wis.; and Kosse, Texas.

The company also operates a fuel processing and distribution business. This unit mainly focuses on acquiring, re-refining and selling transportation mixture, or "transmix," which is a combination of refined products such as gasoline and diesel.

While the fuel business produces most of the revenue at Emerge, the much higher-margin frac sand business delivers the lion's share of net income. It is also a big reason Emerge's stock price has nearly tripled since the company's initial public offering last year.

Logistics Capabilities

"Emerge possesses a solid position within the frac sands market, particularly the coarse frac sands utilized in oily shale plays," JPMorgan analyst Jeremy Tonet noted following Emerge's 2013 third-quarter earnings report.

Demand for frac sand has more than tripled over the past five years amid a sharp rise in oil and gas production in the U.S. and Canada.

One advantage Emerge has over other sand producers is its logistics capabilities, Tonet says, particularly the rail connections it has to both theCanadian National Railway ( CNI ) andUnion Pacific ( UNP ) rail lines at its Wisconsin frac sand facilities. These lines provide low-cost access to many U.S. and Canadian oil and gas shale plays.

"Given that production costs are one of the largest factors in competitive positioning within the frac sands industry, Emerge's low-cost operating structure is an important advantage," Tonet noted.

During the third quarter, Emerge's sand segment produced $47.4 million in revenue and $19.1 million in income. That compares to $222.8 million in revenue and $8.1 million in income from its fuel segment.

The reason for this wild discrepancy is that it costs a lot less to produce frac sand. When frac sand sales rise, Emerge's bottom line gets a huge boost.

Lately, that's what's been happening. Emerge's volume of sand sold during the third quarter more than doubled from the prior year to 734,000 tons. The gain was primarily due to its new Barron operation, which produced 344,000 tons during the quarter.

The additional capacity the Barron facility brings to the table has a couple of advantages, analysts say. One of them is "near-term organic growth opportunities," says Citigroup analyst John Tysseland noted.

In addition, he says, Emerge is "well positioned" to capitalize on the current industry shift to a preferred supplier market for oilfield logistics customers.

Big Competitors

"That will allow them to continue to win new business away from competitors based on their quality of sand and logistics attributes," Tysseland noted.

In addition to Emerge, other publicly traded companies that supply sand for oil and gas production includeHi-Crush Partners ( HCLP ),Carbo Ceramics ( CRR ) andU.S. Silica Holdings (SLCA).

These companies all specialize in slightly different areas.

Carbo produces ceramic proppant and resin-coated sand used in fracking. Hi-Crush supplies monocrystalline sand used as a proppant to improve the recovery rates of hydrocarbons from oil and natural gas wells. U.S. Silica mines and processes commercial silica used as oil and gas proppants and in industrial and specialty products.

Of the four, Emerge is the biggest, with 12-month trailing sales of $1.1 billion, though that's mainly due to its fuel business.

For the first three quarters of 2013 its sand segment posted about $114 million in sales, or 17% of the total. Overall revenue for the period rose 37% from the prior year to $627.2 million. Net income climbed 48% to $21.2 million.

The company is scheduled to report 2013 fourth-quarter results on March 13. Analysts polled by Thomson Reuters expect earnings of 64 cents per unit. No prior-year per-unit earnings are available because Emerge wasn't publicly traded during the fourth quarter of 2012.

The company was formed in 2012 by Insight Equity, a private equity firm based in Southlake, Texas. Emerge went public last May at an opening price of $17. Its shares currently trade near 46.

Analysts expect full-year earnings of $3.04 per unit in 2014 and $3.09 in 2015.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: EMES , CNI , UNP , HCLP , CRR

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