Heckmann (HEK +0.00%) is a very interesting company with an even more intriguing business model. The environmental services company offers oil and gas producers a full-cycle solution for the water used in fracking as well as some ancillary environmental services. Its goal is to protect, enhance, and advance sustainable energy growth; it's doing so not by offering a commodity service to its customers, but instead by supplying a comprehensive solution.
The key to understanding Heckmann is to look at how it differentiates itself from competitors. What the company has done is built itself into a full-cycle environmental service provider through a series of mergers and acquisitions. Today, Heckmann delivers water to the well site, collects it after it's produced, treats and recycles what it can, and disposes of the rest in an environmentally friendly manner. Its advantage here is that it takes a systems approach instead of providing a commodity service such as just water delivery or disposal wells.
The company's advantage is leveraged across a platform which includes a system of assets that's in place across all the major shale basins. The following chart tells its story:
Source: Heckmann Investor Presentations
The question that needs to be asked is if this advantage is durable and if it can be expanded upon and strengthened over time. Many doubt that this will occur and one analyst covering Heckmann recently downgraded it saying that the firm "can't assign a premium multiple any longer to a company that has proven it is in a highly cyclical business with considerable threats."
Those threats are real and come from a variety of sources. One threat is price -- it's a lot cheaper for an oil and gas producer have water trucked in and then bypass the treat and recycle step to move strait to disposing of the produced water. This is what SandRidge Energy (NYSE: SD) does in its Mississippian Lime acreage. The company has developed such a competitive advantage surrounding its salt water disposal system that it has chosen to focus its drilling on areas where it has this infrastructure already in place. The company has invested $600 million to drill 123 disposal wells, which has lowered its need to have produced water trucked out, which in turn has lowered its costs.
The problem with disposal wells though is twofold: First, disposal wells don't solve the freshwater usage problem; second, disposal wells have been linked to earthquakes. While the earthquake issue is still debatable, the freshwater issue is critical because of the sheer volume used that is not solved by disposal. The volume of water used is pretty incredible. Chesapeake Energy (CHK +0.00%), which is one of Heckmann's largest customers, typically uses 5 million gallons of it to drill many of its wells. As you can see in the chart below, water does vary by location:
Source: Chesapeake Energy
Chesapeake is committed to managing its water responsibly which is why it's very active in having its water treated and recycled. As an example, 97% of its wastewater from its northern Marcellus operations is now reused, and while the company is drilling in the Mississippian Lime, some of its wells are using 100% produced water. This trend plays firmly into the continued success of Heckmann.
Unfortunately, for Heckmann at least, is that the idea of using 100% produced water is not lost on the industry and oil-field services company Halliburton (HAL 2.61%) is making great strides in that department. The company's new CleanWave Water Treatment Service trucks take the produced water from fracking and simply reuses it. It takes out what was thought to be the critical treatment step. It's also changed the price point for drillers.
While that's a large and looming threat, the new system has only been applied to around 60 wells in the Permian Basin and Bakken. It likely won't work everywhere as some areas, such as the Eagle Ford, don't give back a lot of water and the Marcellus already has a well-developed recycling system. The potential is there to have a major effect on Heckmann's business, which means that this technology needs to be watched closely.
In the near term, Heckmann's business is being built around its full-cycle system and deep-seeded customer relationships. Because of these relationships as well as Heckmann's growing size and scale it is able to effectively compete based on more than just price.
That's an advantage that appears to get stronger with each passing quarter, as evidenced by the tremendous revenue growth. The company recently reiterated its guidance of $750 million-$825 million in revenue for the year, which is a big jump for a company that delivered revenue of just $153 million in 2009. While it took several mergers to get there, Heckmann's ability to continue to consolidate its way to the top should keep its competitive advantage intact for the foreseeable future.
