ByDavid Forward:
Hi-Crush Partners (
HCLP
) is a domestic producer of premium monocrystalline sand, a
specialized mineral that is used as a "proppant" to enhance the
recovery rates of hydrocarbons from oil and natural gas wells. HCLP
operates as a Master Limited Partnership, and is currently trading
at $20.59. The combination of HCLP's high dividend with the
comparative advantages in its business model offers investors a
powerful upside. Meanwhile, the company's low-risk structure and
zero-debt balance sheet make Hi-Crush an investment opportunity
with very limited downside.
Right off the bat, the most attractive aspect of HCLP is its 9%
yield. In a market of record-low interest rates, this is
significant for investors searching for a stable source of income.
Yet in the analysis below, I'll avoid using this high yield as my
primary justification for buying into Hi-Crush. After all, yield is
worth very little if the company's business model is flawed.
Instead, I'll outline why HCLP's long-term contracts and de-risked
business model make this 9% yield sustainable.
Characteristics of a Master Limited Partnership
An MLP combines the tax benefits of a limited partnership with
the liquidity of a publicly traded company. While MLPs come in all
shapes and sizes, there are 3 basic characteristics to understand
about this structure. First, an MLP must derive 90% of its income
from what the IRS considers "qualifying sources." This generally
refers to the production, processing and transportation of
commodities like oil, natural gas and coal. The second feature of
an MLP is that it is tax-advantaged. MLPs are not subject to
corporate income taxes, which lowers their cost of capital and
frees up more cash to distribute to shareholders. Finally, tax
legislation compels MLPs to distribute 90% of their earnings to
shareholders in the form of regular cash distributions. As a
result, MLPs are noted for their very high yields.
How Hi-Crush Is Different: Limited Downside
Hi-Crush represents a shift away from the traditional MLP. While
MLPs were historically E&P companies vulnerable to commodity
price fluctuations, Hi-Crush is more similar to the natural gas
fracking business model, and its business is characterized by
stable, long-term contracts with established oilfield companies
like Halliburton (
HAL
) and Baker Hughes (
BHI
). These contracts have a longer reserve life, and expose HCLP to
much more limited volume risk. The disparity between Hi-Crush's
business model and those of more traditional MLPs are illustrated
in the table below:
(click to enlarge)
Yet even among these non-traditional MLPs, Hi-Crush offers more
impressive fundamentals than its peers. As you can see below,
Hi-Crush's profit margin outperforms the pack by a wide margin. Due
to HCLP's shallow earth overburden at its Wyeville facility, the
company is able to use surface mining equipment in its operations,
which provides for a lower cost structure than underground mining
operations. In addition, HCLP's processing and rail loading
facilities are located onsite, effectively reducing the cost of
trucking sand to either facility. These advantages result in lower
per-unit production costs and higher profit margins, which will
allow Hi-Crush to weather any market weaknesses better than its
competitors. Meanwhile, the EV/EBITDA suggests the company is
trading at a discount relative to its peers. Best of all, Hi-Crush
carries zero debt on its balance sheet.
(click to enlarge)
Powerful Upside: Company-Specific
The market appears to be overlooking the growth potential of
Hi-Crush's cash distributions. Within a Master Limited Partnership,
the general partner ((GP)), who is responsible for managing the
operations of the business, is given Incentive Distribution Rights
(IDRs). IDRs are structured when the partnership is formed, and
they provide the GP with performance-based pay for successfully
managing the MLP, as measured by cash distributions to
shareholders. Generally, the GP receives a minimum of 2% of the
cash distribution, but as payments to shareholders increase, the
GP's percentage take increases as well, often to a maximum of
50%.
Here's where Hi-Crush differs:
Unlike most of its peers, the share of Hi-Crush's cash
distributions going to the GP is currently 0%. In other words,
HCLP's parent company, acting as the GP, has an incredibly strong
incentive to increase distributions to shareholders and to grow the
business. This is an enormous opportunity for investors, and
Hi-Crush's management will have plenty of room to executive this
strategy as horizontal drilling and hydraulic fracturing continue
to boost demand for raw frac sand.
Powerful Upside: Industry-Wide
Hi-Crush also stands to benefit from growth in the demand for
proppants, which are used to keep hydraulic fractures open. The
industry has grown as a result of the "fracking" boom in the U.S.,
and proppant demand has increased by 28% annually over the past 5
years. Looking forward, demand for Hi-Crush's raw frac sand is
expected to outpace supply, which will fuel higher prices and
continued industry growth:
(click to enlarge)
Source: The Freedonia Group
Conclusion
A 9% yield is always nice, but it means nothing if the company's
business model isn't sustainable. Equipped with a low-risk
structure, zero debt, and a parent company with a strong incentive
to grow the business, Hi-Crush justifies its impressive yield with
the necessary combination of a powerful upside and limited
downside. Hi-Crush offers investors the chance to capitalize on the
booming hydro-fracking industry, and at a time when many investors
are uncertain about how to correctly value a non-traditional Master
Limited Partnership, this an appealing entry point to buy.
Disclosure:
I have no positions in any stocks mentioned, but may initiate a
long position in [[HCLP]] over the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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