Hi-Crush Sand Mine In Wisconsin Profits From Fracking

By
A A A

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 production.

Hi-Crush Partners ( HCLP ), 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 unit holders.

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 ( HAL ) andBaker Hughes ( BHI ). 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.

Quarterly Payout

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 customers.

"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 high-quality customers."

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 holders.

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 prices.

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 drilling activity.

Environmental Concerns

"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 CFO Fulton.

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 advantages.



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: BHI , HAL , HCLP

Investor's Business Daily

Investor's Business Daily

More from Investor's Business Daily:

Related Videos

Can You Talk Sexy Money?
Can You Talk Sexy Money?            

Stocks

Referenced

Most Active by Volume

16,191,050
  • $16.91 ▲ 0.54%
15,174,545
  • $4.9975 ▲ 3.90%
11,437,312
  • $6.58 ▲ 0.23%
8,246,544
  • $2.29 ▲ 10.10%
8,238,510
  • $98.89 ▼ 0.29%
8,035,478
  • $13.14 ▼ 1.20%
7,457,039
  • $97.03 ▼ 0.19%
7,083,502
  • $76.90 ▲ 0.46%
As of 10/2/2014, 10:15 AM

Find a Credit Card

Select a credit card product by:
Select an offer:
Search
Data Provided by BankRate.com