Wall Street wasn't impressed with Emerge Energy Services (NYSE: EMES) second-quarter results: Traders sent the stock down more than 10% on Wednesday after it announced earnings. Not only did the company miss expectations, management indicated that it was seeing a minor slowdown in the frack sand market. Funny thing, though: There aren't many other frack sand suppliers echoing that sentiment.
Let's take a look at what happened this past quarter, and why Emerge seems to be hitting a soft spot when others aren't.
By the numbers
|Metric||Q2 2017||Q1 2018||Q2 2018|
|Revenue||$101.8 million||$106.7 million||$82.6 million|
|EBITDA||$21.5 million||$16.9 million||$7.3 million|
|Distributable cash flow||$17.3 million||$8.7 million||$2.6 million|
Emerge's revenue and earnings seem to be stalling out a bit lately. Revenue for this quarter was actually down compared to six months ago even though volumes are up considerably. While management said that rail disruptions were to blame for lower margins and weak cash flow numbers in Q1, the issue this time was that fewer sales originated from its own terminals -- 26%, compared to 39% in Q1 -- and that sales through other terminals carry lower margins.
The one upbeat point in the report was that facility costs were down. That's partly because Emerge is getting some production from its new sand mine near San Antonio, and partly because its Wisconsin facilities are running at full capacity, which lowers per unit costs.
What management had to say
If Emerge's lower-than-expected earnings weren't enough of a concern, Chairman Ted Beneski's press release statement on the company's outlook suggested that the frack sand market is weakening.
The demand for frack sand remains healthy, but we experienced a minor slowdown to finish the second quarter, and the softness has partially continued into early third quarter. Conversations with our customers indicate that the conditions are temporary given the Permian takeaway constraints. However, we acknowledge that the frack sand industry faces a state of transition with the utilization of new in-basin plants increasing throughout the year. As a top-five producer in the frack sand industry in the United States, we believe we are at the forefront of diversifying our business model to meet the new needs of the industry with both northern white and in-basin capabilities.
Here's the strange part about this statement: None of Emerge's competition mentioned anything about a slowdown in demand. Instead, they were talking about how strong demand is in places like the Permian Basin. Hi-Crush Partners just last week announced a supply contract that will require it to construct a new 3 million ton per year facility in the Permian just to meet demand.
Not in the best competitive position
Over the past 18 months, every frack sand supplier has benefited from the same macro trends. Drilling activity is up on higher oil prices, and the amount of sand used per well is way up because producers have found that using more improves well economics. Now that those trends have played out, and the frack sand market is becoming more competitive again, the wheat is getting separated from the chaff.
Unfortunately, Emerge's position is weaker than many of its peers. It doesn't have any in-basin supply in the Permian Basin, it doesn't offer the last-mile logistics services that attract long-term supply agreements and wider margins, and its current operations still aren't generating enough cash to distribute to shareholders.
Management is trying to be clever by focusing its efforts outside the Permian, as an in-basin supplier for other shale regions such the Eagle Ford in South Texas and the Anadarko in Oklahoma. Management has struggled to get its Eagle Ford facility up and running, though, which isn't a great sign.
It may have been worth deferring judgment on Emerge while it brought these new facilities on line, but it's looking more and more like its operations just don't hold a candle to those of its competitors.