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Does CARBO Ceramics Deserve Its New Valuation?

Wall Street panicked when ceramic proppant manufacturer CARBO Ceramics (NYSE: CRR  ) reported first-quarter earnings this year and promptly sent shares 17% lower. Analysts kicked the stock around for a few months until second-quarter results came in ahead of expectations, and then suddenly remembered they loved the company after all and sent shares 17% higher. Shares continued to trek higher until third-quarter results were announced last week, when they exploded 28%.

CRR Chart

CRR data by YCharts

What's driving such sudden knee-jerk movements for a relatively established company? Why haven't peers such as U.S. Silica (NYSE: SLCA  ) and Hi-Crush Partners (NYSE: HCLP  ) experienced the same volatility? And most importantly, can CARBO sustain its new valuation? Let's evaluate.

Drilling activity, energy prices drive proppant sales
A record amount of rigs combined with the economic crisis in 2009 to destroy natural gas prices, which remained low as new extraction techniques flooded the domestic market with natural gas. Meanwhile, oil prices, anchored by international market demand, rebounded much more quickly after the recession and were the driving force in rig additions.

On-shore rigs only. Present year data represents nine-month average. Source: Energy Information Administration.

Rig count is highly correlated with commodity prices.

WTI Crude prices at Cushing, Okla. Present-year data represents nine-month average. Source: EIA.

The country's natural gas rig count is still down from 423 at the end of 2012, but it has rebounded from a low of 352 in June 2013 to 388 at the end of September. That is no doubt in response to an uptick in prices and a positive indicator for proppants manufacturers. While the proppant industry braced itself for low drilling activity in 2012 and the beginning of 2013, low demand seemed to linger a bit longer for CARBO's engineered products compared with sand products offered by competitors.  

Divergent paths
Hi-Crush and U.S. Silica mine and sell sand as a proppant. It's cheap, requires little to no processing, and gets the job done for shallow wells. CARBO manufactures high-quality ceramic and resin-coated sand proppants that require a fair amount of processing but fetch higher prices and work much better than sand in deeper wells. And unlike CARBO, the pair is unlikely to face cheap competition from the Chinese market (how much cheaper can sand get?). Pricing pressures and demand have resulted in divergent paths for the three companies in recent quarters.


Q2 13 Sales

Q1 13 Sales

Q4 13 Sales


$27.1 million

$19.6 million

$16.2 million

U.S. Silica

$129.8 million

$122.3 million

$118.8 million

CARBO Ceramics

$153.7 million

$147.7 million

$153.6 million

Source: Google Finance.

Low-priced sand was more attractive than high-priced ceramics for the first half of 2013, as both Hi-Crush and U.S. Silica were able to grow sales in each subsequent quarter. Wall Street analysts got a little worried with numbers to start the year but were just losing their minds with short-term models. CARBO sold a record amount of proppants in the third quarter and set a new watermark for quarterly revenue, too, at $201.5 million. The company even resorted to drawing down inventory to keep up with growing demand from the Bakken, Eagle Ford, and Permian shale plays -- an indicator that growth is here to stay, perhaps? 

You may have caught an easy double with CARBO if you saw the buying opportunity earlier this summer. Easier to say in hindsight, of course, but the indicators were there. The company was adding manufacturing capacity, increasing awareness about the dangers of low-quality ceramic proppants from China, and bound to capitalize on a rebound in natural gas prices.

Are CARBO shares worth it?
It appears that as long as energy prices remain strong, so, too, will demand for proppants. There are innovative new technologies being introduced that drastically reduce the amount of proppants required for a well, but proppants will continue to be an important part of the country's energy future. CARBO shares aren't cheap at a forward P/E of 28, but I don't think it's unrealistic for the company to top estimates for 2014 EPS of $4.52 per share if drilling activity remains strong. I can't promise that shares won't pull back after the recent pop, either. But if you believe in the long-term forces driving America's energy boom, maybe you should keep an eye on this high-quality proppant manufacturer.

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