Why I’m Buying Hi-Crush Partners

You're probably well aware of the fact that energy companies use vast amounts of water and sand in the fracking process. However, you might not know that sand is just one of many proppants used by the energy industry. The growing use of proppants has its producers piggybacking on the shale boom and in so doing, offering investors an interesting way to invest in the growth of oil and gas production.

As I personally dug deeper into the proppant industry I became convinced that this was a story worth owning. Last week I decided to commit some of my own capital to the industry and welcomed Hi-Crush Partners (NYSE: HCLP  ) to my portfolio. I thought I'd share with you why I felt compelled to invest in this proppant producer.

What's a proppant?
Proppants are used by the oil and gas industry to prop up the fractures in a well to enhance the flow of oil and gas out of the well. There are several types of proppants with Hi-Crush and US Silica Holdings (NYSE: SLCA  ) both producing raw frack sand while CARBO Ceramics (NYSE: CRR  ) produces both a ceramic proppant and resin-coated sand.

Sand is the low-cost option for producers but it's not always the best option. Because CARBO's ceramic proppants are of a uniform shape and size, it allows for more oil and gas to flow through. That being said, more than three-quarters of the proppant market is raw frack sand. It's a market that's projected to nearly double over the next 10 years from 16.7 million tons in 2011 to 31.5 million tons by 2021 as you can see from the following chart: 

Source: Hi-Crush Partners 

With frack sand being a volume market, I'd prefer to stick with the lowest-cost producer and Hi-Crush Partners is among the best in that department. 

Why Hi-Crush Partners?
Not only is Hi-Crush a pure-play, low-cost producer of frack sand, but I'm drawn to the fact that the company is structured as a master limited partnership. As such, Hi-Crush distributes most of its earnings back to unitholders. At last count that amounted to $1.90 in annual distributions and equated to a yield of nearly 10%.

For my money, Hi-Crush is a better bet because it offers me a simple pure play on the growing frack sand market. US Silica, on the other hand, is more diversified as it boasts over 200 products and 1,400 customers. While that might appeal to other investors, it wasn't what I was looking for. Meanwhile, CARBO's products are not expected to take market share from raw frack sand so while its overall market will grow, it doesn't appear that it will claim much, if any, of the raw frack sand market.

What's the risk?
The biggest risk for Hi-Crush is customer concentration. One of its four main customers, Baker Hughes (NYSE: BHI  ) decided to bail on its contract last year. That sent shares of Hi-Crush down sharply and the loss of another customer could signal greater problems at the company. A core thesis to owning Hi-Crush is the long-term contracts it has with customers which secures the high investor payout. Currently, the company has fixed price contracts with an average life of more than three years. If the security of these contracts begins to crumble, it could be time to walk away.

Final Foolish thoughts
One final note, I did not buy shares outright. Instead, I wrote puts in order to buy shares cheaper or to earn income. For me, this was about managing my risk giving the fact that the market seems to be hitting new highs almost daily. That being said, I think Hi-Crush will end up being a long-term winner for my portfolio and I'd just prefer to buy it a bit cheaper.

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Read/Post Comments (4) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 03, 2013, at 10:27 AM, texasoilman wrote:

    I owned many shares of SLCA which I purchased by doubling down after it sank to ten bucks. I sold out after the 8 mil share sale announced by the real owners ,,,, that is private equity. I would like to own shares in a company that is doing a buyback, but the private equity boys are and will continue throwing their shares on the market , none of which will accrue to the benefit of the company. As the price goes up the Private equity guys will drive it back down with their millions of shares. I will take the the 10 % distribution from Hi Crush and you should do the same.

  • Report this Comment On April 03, 2013, at 12:06 PM, GoHorns12 wrote:

    You sold puts on HCLP? The option market for MLP's is notorious for being thinly traded. You most likely got taken on the bid/ask which is pretty tough to recover from.

  • Report this Comment On April 03, 2013, at 2:15 PM, TMFmd19 wrote:

    @GoHorns12 - Not if you split the bid/ask with a limit order and just wait for a fair price. I'm mainly interested in attempting to buy the units cheaper, but I did get a decent price for the puts.

    Matt

  • Report this Comment On April 03, 2013, at 2:16 PM, TMFmd19 wrote:

    @texasoilman - Hi-Crush does have a sponsor that owns the General Partnership. Given what you said about SLCA, you might want to dig into HCLP's sponsor and make sure you're comfortable with that relationship.

    Matt

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