“Super Sand: Horizontal Drillers Can’t Operate Without It”

Friday File look at an Elliott Gue teaser

A few readers have asked me about this one, and I’ve got sand on the brain since I’m putting in a patio tomorrow if I can get my lethargic heinie out of bed in time, so I thought I’d take a look for you in today’s Friday File.

And yes, I do wish that I had a bucket of cash sitting on the sideline right now — for an optimist like me, these days of dismal jobs reports present saliva-worthy buying opportunities. Just a quick scan across my screen makes me want to look a little closer at companies I’ve mentioned to you in the past but haven’t bought yet like Cummins (CMI), Superior Plus (SPB, SUUIF), Arcos Dorados (ARCO) or A.O. Smith (AOS), and to consider adding to holdings in extremely strong stocks that are dipping like Apple (AAPL) or dividend plays like Intel (INTC), Retail Opportunity Investments (ROIC) or Sprott Resource Lending (SILU) … heck, even stocks I’ve sold in the past like Westport Innovations (WPRT) and Corning (GLW) are starting to look decent again with these lower prices. The big picture may be bleak in a lot of places, but businesses will keep churning away … and many of them will keep making money. Too many things I want to buy, too little cash.

So as I sit paralyzed, for at least a moment, by indecision, I take up Elliott Gue’s fracking sand teaser — it’s not a super-hard one to solve, but it is an interesting company and it has gotten absolutely clobbered in the last couple weeks. Opportunity? Maybe, let’s take a look:

“Super Sand

“In the booming shale industry, this indispensable, highly coveted sand is termed the “new gold.”

‘It’s a gold rush. Demand for ‘frac sand’ is jumping through the roof.’ —Thomas Dolley, U.S. Geological Survey ….

“The shale revolution in the U.S. is here to stay.

“But a huge and growing shortage of high-quality silica sand for fracking poses a challenge for oil and gas producers.

“Demand for the indispensable sand is at an all-time high—increasing since 2004 at a rate of 28% a year and projected to rise at least 15% a year to 2015. The kicker: You can’t operate an efficient horizontal well without the stuff.

“The essential role of this remarkable sand is the most overlooked story of the Great Shale Revolution.

“It’s also a golden opportunity for the smart, aggressive company that’s my new top-secret recommendation.

“I expect their earnings to grow at an annualized pace of 30% to 40% over the next few years. How can I be so sure?

“Let’s just say selling a product for twice the cost of production is one heck of a sound business strategy.”

Sounds compelling, right? I’ve spent a fair amount of time in recent years looking at “picks and shovels” type companies, the firms that benefit from a boom without being directly related to the commodity pricing or the mania — in the case of hydraulic fracturing there are a lot of oil and gas companies that have had poor results, or who have been levered too much to natural gas in the last year when that price was falling, and they’ve taken some serious hits in a few cases … but, theoretically at least, the service providers and equipment providers ought to have a somewhat more stable outlook. As long as exploration and production continue in either gas or oil, the argument goes, the service companies should face solid demand and decent pricing as long as capacity doesn’t expand too quickly.

It doesn’t always work out so cleanly, of course — many service providers are levered to a few companies, or, in practice, have more customers in gas exploration than in oil, so there have certainly been drillers and frackers who have seen their share price get beaten down (including one I own and have profiled for the Irregulars in the past, Canyon Services).

But sand, now this is a concept I hadn’t thought of before — we talk quite a bit about water when it comes to fracking fluids, and about the need to either try to frack without water (Gasfrac) or to clean or store or treat that water effectively and efficiently (we talked about a few of those companies here), but we don’t hear as much about demand for the actual proppants. There have been some teaser campaigns and pundit interest in “new material” fracking companies over the years, including the ceramic proppants made by Carbo Ceramics (CRR), which has been cut in half over the past year, and even the new proppants being developed by Canyon, but I don’t think I’ve heard anyone excited about sand and silica since the brief solar-inspired craze for polysilicon about five years ago.

And apparently that’s because … there hasn’t been a “pure” fracking sand investment to tout and tease, until now … according to Gue:

“my new recommendation is a top producer of commercial-grade silica sand for fracking—the best sand, my sources tell me, in the business.

“And—to repeat—silica sand is just about the hottest commodity there is in the booming U.S. shale industry.

“The First Pure Play on Fracking Sand”

Gue then goes on to explain what this stuff is for a few moments:

“In 2010, fracking sand production doubled to 13 million tons. In 2011, it jumped to 28.7 million tons. It will soar again this year. Yet the shortage remains.

“Since there’s no end in sight for the shortage, prices for fracking sand are not coming down anytime soon.

“You may be wondering: What is this stuff—and what the heck does it do?

“Silica—or fracking sand—is made by extracting quartz from open-pit mines and crushing and processing the mineral into sand….

“Today, the energy industry is the largest single market for silica sand, and this growth should continue in coming years.

“While silica sand is essential to the fracking process, not all sand is equal.

“The white Ottawa sand my top pick produces is by far the best sand for extracting oil and NGLs from shale reservoirs. As drilling activity shifts in favor of oil, sales of the sand my pick specializes in should continue to see outsized growth.

“You see, high-grade fracking sand must be hard enough to withstand the intense pressure of the fracking process. But it must also be rounded to allow the oil and gas to easily escape into the long horizontal wells and rise to the surface where it’s extracted….

“The proppant is mixed into the fracturing fluid. Pumped deep below the surface, the proppant enters the fissures created during the hydraulic fracturing process and literally props them open so the cracks don’t close up once pressure is removed.

“As I pointed out earlier, you literally CAN’T operate productive horizontal wells without the sought-after fracking sand this company makes.”

So that’s what it is — who’s the company?

“… my top pick produces their commercial grade sand for only $25 a ton—and then sells it for about $50 per ton.

“That’s a 100% mark-up that could go even higher.

“According to the CEO of a top independent oil and gas producer, “Those who have sand or access to sand can pretty much charge what they want for that sand.”

“This is like a license to print money.

“Little wonder my recommendation saw its sales reach $295 million last year—and expects sales to rocket to $400 million this year.

“This led my pick to go public—the first pure play on fracking sand—in order to raise capital for a new facility to coat their sand with resin for increased strength.”

And a few more details:

“… the company boasts a total of 316 million tons of silica sand reserves, about 148 million tons of which are top grade. That means roughly half of their silica reserves are ideal for use in fracturing….

“Transportation can be the most important cost of supplying fracking sand. Management believes they are the only proppant producer capable of delivering product to all of the major shale fields in the U.S.

“The cherry on top of this cake: My top pick is one of the only producers to meaningfully expand its silica sand production capacity.

“Last year, the firm increased the capacity of its production facility in Ottawa, Illinois, by 1.2 million tons and expanded capacity at a plant in Michigan by 200,000 tons.”

So who is it? Well, dear friends, as we were told, this is the only US fracking sand producer to have gone public, and it did so earlier this year — so that narrows the list considerably. To one, actually — this is U.S. Silica Holdings (SLCA)

They went public at $16-17 in February, and enjoyed a brief surge thanks to their “pure play” status and the fascination with fracking growth — but have since fallen considerably, including a 10% drop today (when almost everything else was falling, too — but not by 10%). Priced at just under $11, it’s been cut roughly in half since it’s high in the low-$20s. Which is a big swing for a company that has been traded for less than four months, though it’s not atypical for it to take a while for the market to figure out a company — particularly when it doesn’t have any public competitors.

SLCA was brought public by a venture capital company/hedge fund, Golden Gate — and they still control more than 75% of the shares. As is typical of private equity-backed IPOs, the company itself didn’t raise that much money in the IPO — they did raise enough to fund some more of their capital expansion (they’re expanding capacity pretty aggressively to try to get in front of, or maybe even anticipate, demand from oil and gas companies), but it was Golden Gate that did most of the selling to generate some gains from their backing of SLCA.

I do think that demand for fracking sand will remain high, and that though they’re arguably being a bit aggressive I think it’s a reasonable bet to continue investing in expansion … and I think the valuation is quite reasonable, they’re trading for about 12 times last year’s earnings and five times projected earnings, so I think there might be some promise in this one if you can stomach the big selling pressure. Given the fact that Golden Gate still owns about three quarters of the shares and will probably want to offload those shares in the next couple years, you could be forgiven for not wanting to step underneath a falling knife with this kind of selling pressure (and a pretty big short interest — 15-20% of the float as of the last data I saw … though, given the very low float with Golden Gate’s huge ownership, that could also easily generate a “short squeeze” and force the stock to pop, at least temporarily, if there’s any buying pressure at all from, for example, a good earnings quarter).

I’m putting this one on my short list to keep an eye on — there doesn’t seem to be any urgency, since they’re weak in part because of bad sentiment for natural gas projects, and the earnings release was just a couple weeks ago so there probably isn’t anything material on the horizon in terms of announcements, but I do like the business as a long-term grower predicated on the continuing demand for silica. I’ll keep looking into this one, and watching to see if Golden Gate continues offloading shares (I haven’t checked what their lockup is for additional sales after the IPO), and if something stands out as a reason to definitely buy I’ll be sure to share my thoughts … for now, it’s interesting but I don’t feel the lust to buy shares right this moment.

What do you think? Interested in jumping right on the SLCA bandwagon?

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2 Comments on "“Super Sand: Horizontal Drillers Can’t Operate Without It”"


June 19, 2012 4:33 pm

I’m fracking up to my eyeballs in this area:LNG ( net exporter with not enough tankers….should buy GLNG,TGP) ,CLNE ( stick with T. Boone Pickens),KOG, but the best is FTK with fracking fluid, among other things, that replaces the benzenes which is ,buzz,buzz, “nano” based and enviromentally friendly. Enough so, I can put on my Cheerios. Sales leaping upwards with great future earnings announcements. HAL apparently also has a frendly fluid. So where is the NAT GAS bill? The senate is so full of it, they can’t pass more.

Myron Martin
June 20, 2012 3:43 pm
What SHOULD happen based on logic and research often does not simply because up beat analysts are so attuned to the status quo they fail to consider the Macro picture of world economics. The last year has seen the most difficult investment climate in decades simply because the very foundations of our existence, our monetary system is badly flawed and is finally coming unglued. The duct tape, chewing gum and baling wire patch up jobs being employed by the Eurocrats and Central Bankers is not working, can not work and will not work. Until the powers that be realistically tackle… Read more »