Wisconsin is one of the swing states that could hold the key
to November's presidential election.
It also holds one of the natural resources that is key to the
renewed burst in U.S. oil and gas production.
Northern White sand, most abundant in Wisconsin, is used in
combination with water and chemicals in hydraulic fracturing to
prop open cracks in rock holding oil and gas. For all its
environmental issues, fracking has helped boost U.S. oil and gas
Hi-Crush Partners (
), coming off an August IPO as a master limited partnership, is a
major player in the Wisconsin sandbox. Created to encourage
investment in energy infrastructure, MLPs offer tax advantages to
Hi-Crush qualifies as an MLP because it owns and operates a
sand mine and processing facility with 48 million tons of
recoverable sand. This equates to a 33-year reserve life, says
RBC Capital Markets analyst T.J. Schultz. (RBC was a co-manager
of the IPO.)
Hi-Crush sells its sand under long-term contracts to large oil
service contractors likeHalliburton (
) andBaker Hughes (
). It may soon add a second facility now owned by Hi-Crush
Proppants, its general partner. Analysts expect the publicly
traded MLP to purchase the Augusta, Wis., facility sometime next
year from its general partner, which would nearly double its
output and cash flow.
Hi-Crush CFO Laura Fulton expects Hi-Crush to offer a minimum
quarterly distribution of 47.5 cents per unit. That's a $1.90
annual distribution, which equates to a roughly 9% yield with
Hi-Crush units currently trading at just near 21. As limited
partners in the MLP, unit holders can defer taxes on 40% of the
distribution income they receive.
Analysts like the combination of solid and predictable growth
in revenue and distributions, along with the base of powerful
"There's good visibility on continued cash flow growth and
distribution growth," said Schultz.
"This is just one piece of the very large puzzle that is
supporting the U.S. oil and gas renaissance," said R.W. Baird
analyst Ethan Bellamy. (R.W. Baird was also a co-manager of the
Hi-Crush IPO.) "They take a business that could be volatile and
smooth cash flows by virtue of multiyear contracts with
Proppants are substances mixed with water and chemicals in
fracking. Hi-Crush has no stranglehold on the proppant business.
There are a variety of proppant alternatives to Hi-Crush's
Northern White sand. But the Hi-Crush sand is valued for its
ability to withstand high pressure. Resin-coated and ceramic
proppants may be more attractive for certain kinds of wells,
notes Bellamy. But, he added, "the go-to product for most wells
of middling pressure would be this white sand."
And with close access to rail lines, Hi-Crush is a low-cost
sand producer. "They have some of the lowest costs in the
sector," said Schultz.
But nobody is going to get a 9% yield without taking on some
risk. There are several potential concerns for Hi-Crush unit
The primary issue, says Bellamy, is reliance on a single
operating facility. "If anything goes wrong with that facility,
it puts the distribution at risk," said the analyst.
There are also some more general risks.
Sales of sand and other proppants have all benefited from
increased drilling activity. But the abundance of recoverable
natural gas has markedly depressed prices. Many drillers have cut
back, unwilling to produce and sell at historically low
A worsening downturn in drilling would lower demand, and hence
market prices, for sand. Even though the average length of
Hi-Crush supply contracts is 4.6 years, customers could demand to
renegotiate terms if market prices tumble.
"It's possible," allowed Schultz. CFO Fulton agrees that
renegotiation is a risk, but not all that likely. "We believe our
contracts are very strong," she said.
A further contract risk is concentration in the customer base,
Morgan Stanley analyst Stephen Maresca noted in a September
research report. (Morgan Stanley was a lead manager of the
Hi-Crush IPO.) "Customer concentration risk" is one factor that
steered Maresca to an equal-weight rating. Risk and reward in
Hi-Crush are "fairly balanced," he concluded.
Investors who buy the MLP units should also be aware of
potential conflicts of interest between general partners and
limited partners (unit holders). General partners, for example,
have incentives to increase the number of LP units. This would
dilute the value of existing positions. CFO Fulton acknowledges
the potential for conflict. But she points out that a conflicts
committee is being formed to iron out such issues.
Environmental worries and even fracking's potential role in
triggering earthquakes have prompted more regulation. New York
State has yet to lift its moratorium on fracking, pending further
analysis. "There's certainly going to be continued focus on
environmental issues. I don't think it's anything that will go
away," said analyst Schultz. But he doesn't expect new
regulations to seriously impact or outlaw drilling. There may be
some new regulations that bring "marginally higher costs to
drilling," he says, but nothing that would severely curtail
"I personally don't see that fracking will ever be banned on a
nationwide basis," agreed Fulton.
Hi-Crush may actually benefit from environmental concerns of a
different sort. Many communities in Wisconsin have withheld
permits for sand mining facilities.
Concerns over trucking activity, along with the health effects
of airborne silica, have been factors in permitting delays and
moratoriums in several counties.
This has slowed the entry of new sand mining rivals into the
market. "We believe that is a significant barrier to entry," said
In this respect, Hi-Crush is sitting pretty. While potential
sand mine rivals struggle to get local permits, both the Wyeville
and Augusta facilities have already cleared those hurdles. "With
Wyeville and Augusta, Hi-Crush has a proven ability to navigate
the local regulatory environment," said Schultz.
In industries dependent on regulation, the willingness and
ability to rapidly comply can confer powerful long-term