I'm a long-term bull when it comes to energy -- particularly oil and natural gas. And while I already have GulfMark Offshore
There's going to be plenty of room for offshore drilling over the coming years. Heck, management for National Oilwell Varco
CARBO sells proppant to oil and gas E&Ps that are exploring for the stuff onshore. Proppant is material from sand, to resin-coated sand, to ceramic particles (CARBO's specialty) that helps in fracking recovery efforts. The higher the grade of material (ceramic is the highest), the higher the conductivity, meaning better recovery and higher estimated ultimate recovery.
Split open and melt
There are a number of reasons that CARBO is looking pretty good to me right now.
The mood is undoubtedly dour. The price of oil is starting to creep back up a bit, but natural gas is at a 10-year low. In fact, some of the biggest names in the industry, including Chesapeake Energy
Did you say limbo? There is a difference between horizontal and vertical fracking. Vertical goes straight down to known wells to pull what it can. Horizontal fracking, however, starts out going straight down and then makes its horizontal turn in order to reach a much wider area of rock or shale using significantly fewer entry wells. Management noted the growing trend toward horizontal fracking on the last earnings call, and this is important as horizontal fracking uses 10 times the amount of proppant that vertical fracking uses. It makes sense that CARBO is expanding its capacity via a new production plant in Georgia; it sounds like it may need it.
The business is solid. CARBO is the largest producer of ceramic proppant, and it's been growing this reputation since 1979. CARBO produces the highest-quality and highest-conductivity ceramic proppant with the broadest product range to fit virtually any need. In short, we have a market leader that is set on meeting the market's ever-changing needs.
Chalk dust torture
No investment is complete without a nice menu of risks to consider:
Reliant on the power of a few. Halliburton Energy Services and Schlumberger
That which helps can also hurt: Natural gas is a significant component of CARBO's direct manufacturing costs. So when (not if) prices start going back up, this can eat into profitability. Of course, management hedges for this, but even hedging is an educated guess, and nothing is certain.
Others may cut and run: When management indicated in the fourth-quarter earnings call that the industry pullback in activity in the Haynesville shale resulted in a 70% hit to their proppant sales in that region, the stock got hammered, and understandably so. But CARBO has significant operations in seven major shale areas in North America alone, and it is not completely dependent on any one.
How much for your wings?
Analysts estimate CARBO will generate about $730 million in revenue for 2012. Seems reasonable, as revenue has grown at an 18% annualized clip since 2003. The current environment presents its share of challenges, but I'm making the bet that over the longer term, natural gas prices are going back up. With the added capacity, CARBO can achieve a 33% EBITDA margin, giving it about $241 in EBITDA for 2012. Tack that onto an EV/EBITDA multiple of 11 (it has averaged 13 since 2003), and we get a stock that could be worth around $120, implying a fair price today for a long-term growth prospect.
Movin' on down the line
There's a lot to like about CARBO Ceramics. It's a small cap; it's in oil and gas equipment and services; it offers a compelling product in a big industry; it has an experienced management team in line with shareholder values; and it seems like a pretty good deal today. So I'm plunking down $1,000 and adding it to the portfolio, making it 20 companies that now call the Motley home sweet home.