Recently, the partnership Hi-Crush Limited Partners
The business
Hi-Crush owns and mines "Northern White" sand, which exists mainly in Wisconsin and few other places in the upper Midwest. It's highly valued by drillers as a proppant because it surpasses American Petroleum Institute, or API, standards. The company's 561-acre facility near Wyeville, Wisconsin, can deliver 1.6 million tons of frac sand annually, with the help of an integrated rail infrastructure that connects right to a major rail line. Hi-Crush is conservatively financed, with no debt and a $100 million credit facility.
The company has long-term take-or-pay contracts with major service providers, including subsidiaries of Baker Hughes
The company expects to continue to sell the majority of its sand under long-term agreements. It now has four contracts with a weighted average of 4.6 years to expiry. Reserves should last 33 years.
Demand for proppant has followed the rapid rise of fracking as an economically viable drilling technique, growning 28% annualized from 2006 to 2011, though rig count grew at only 2.6% annually. Demand should continue to grow as long as drillers continue to exploit unconventional energy sources. Analysts expected the market to grow at 7.2% annualized through 2016. In addition, operators are looking for cheap ways to increase per-well production, and Hi-Crush's low-cost sand helps them achieve that goal.
There are several barriers to entry here. It's difficult to find sand that meets API standards, and if you do, it's difficult to find a source large enough that justifies investment. And then there's the location roadblock -- securing resources that are close to low-cost rail transportation or near major shales.
Two things concern me here: the company is still largely owned by the private equity company that sponsored the recent IPO. That PE investor owns and operates other competing sand mines that it would like to sell to Hi-Crush as the company looks to expand -- a clear conflict of interest. Mitigating that is the fact that Hi-Crush management owns 39% of the IPO sponsor, and a director and the CFO have acquired 25,000 and 10,000 shares, respectively, in the recent IPO.
Also of concern is that the sponsor, which is the accounting predecessor for financial reporting purposes, "has a material weakness in its internal control over financial reporting." This discrepancy had to do with having too few accounting personnel and thus the inability to segregate functions to properly review the accounting process. This is perhaps the most concerning element, and I want to see it remedied in the near future.
My expectations
The stock will pay out $1.90 in distributions per share to start. At the price of $21.43, that comes to an annual yield of 8.9%. Common stockholders have some protection on this distribution in the form of subordinated units, which will receive no payout until the common holders have gotten theirs, a typical structure for this type of transaction.
I expect the stock to trade up based on the yield, similar to my thesis on CVR Energy Partners
|
Dividend Yield |
Resulting Stock Price |
Upside |
|---|---|---|
| 8.0% | $23.75 | 11% |
| 7.5% | $25.33 | 18% |
| 7.0% | $27.14 | 27% |
| 6.5% | $29.23 | 37% |
| 6.0% | $31.67 | 48% |
I've seen a "normalized" yield at around 6.5%, so I expect that price gap to close as investors become aware of this dividend play and its dividend begins popping up on more public finance sites and brokerages.
How will that yield grow?
One other catalyst could be a future acquisition that leverages this pristine balance sheet, which would provide growth and likely send shares up. We know that Hi-Crush would like to grow and that its private equity sponsor has the facility to sell.
Conclusion
The next market day I will add $1,000 in shares to my Special Situations portfolio. I expect this stock to go on to beat the market over the next couple years.
