America's fracking boom is one of the strongest megatrends in the global economy and offers long-term investors many ways to build immense wealth and income. This article is designed to highlight a new MLP (master limited partnership) whose specialized niche is likely to experience strong growth for many years to come. This growth will secure and grow a generous yield and strong capital gains as well.
Fracking sand: pick and shovels for the new gold rush
Hydraulic fracturing of shale formations involves high-pressure water breaking apart rock that contains oil and gas. A single well typically cost $4 million to $12 million to drill and so E&P (exploration and production) companies want to make sure to maximize the output of each well.
This is were the use of proppants comes in. These are substances such as sand or ceramics that "prop" open the cracks in the rock and help maximize the flow of oil and gas. The majority of the proppant market is supplied by sand, which is lower cost than ceramics. Which brings me to the opportunity I want to bring to the attention of investors.
Emerge Energy Services (NYSE: EMES) is a new variable distribution MLP that operates in two segments: fuels and fracking sand. It has no general partner, incentive distribution rights, or minimum quarterly distribution. Instead it pays out 100% of distributable cash flow to its unit holders. Long-term contracts are designed to minimize cash flow variability and prevent the kind of high distribution variability seen in typical variable MLPs (such as refiners or fertilizer partnerships).
The fuel segments specializes in processing and selling "transmix" fuel. This is a mixture of oil refining products, usually gas and diesel, created in the oil refining process.
This segment generates 85% of revenues for the partnership yet just 24% of operating profits.
When it comes to Emerge Energy, the growth story is the subsidiary -- Superior Silica Sands. The demand for proppants is expected to increase by about 30% between 2013 and 2016 and Emerge Energy is well positioned to capture a good deal of this growth.
The partnership has total reserves of 108.4 million tons of high quality sand located at sites in northern Texas and Wisconsin. Its annual capacity is 7.6 million tons and one of its key competitive advantages is its superior logistics management. This includes relationships with Canadian National Railway and Union Pacific and a fast growing fleet of railway cars (3,400 cars growing to 5,800 within a year) for transporting its sand to key shale areas across America and Canada from 19 transportation hubs.
The partnership is planning for aggressive expansion with two new mines in Wisconsin (to be completed by the end of 2014) that will cost $110 million but increase capacity by eight to nine million tons of sand/year (112% capacity increase).
In addition, the MLP is constructing a major new distribution terminal in Sexsmith, Canada (12,000 tons of sand storage capacity) which is to be completed by mid-2014. This new site will serve the growing demand of the booming western Canadian shale region.
The rapid growth of its fracking sand division has allowed Emerge Energy to rapidly grow its distribution since its IPO in May 2013 (from a pro-rated $0.7/unit to $1.13/unit in the latest quarter).
Management is guiding for 2014 distribution of $3.4/unit -$4/unit (thus far it is beating its guidance), which gives an anticipated yield of 3.9% to 4.6% (5.5% if the current distribution holds). The unit price has been on a tear, up 416% in the last year, and the reason why is clear. Emerge Energy is one of the fastest growing MLPs in one of the fastest growing energy sectors. According to Fastgraphs, analysts are expecting 35.2% CAGR EPS growth over the next decade and distribution growth of 32.7%.
Given the growth potential of this MLP (growth projections normally only seen in tech companies) income investors should keep Emerge Energy in mind for a small initial position (or at least a spot on their watch lists).
Foolish takeaway
Emerge Energy Services represents one of the best ways for income investors to play the ongoing shale fracking boom. The variable nature of the distribution, though less variable than refiners or fertilizer partnerships, will likely create future buying opportunities that will allow patient investors to lock in yields superior to today's 5.1% yield. With the fracking megatrend likely to accelerate in the near-term and remain strong for decades to come, this MLP is one that patient, long-term income investors should consider.
