Eagle Materials (NYSE:EXP) has a rock-solid business, literally. The company is a manufacturer of cement, wallboard, paperboard, and aggregates. It might sound like a boring business, but it is an important one. These basic materials are essential in both residential and commercial construction. But recently, the company is supplying the energy industry with a much-needed product. What is this product? Drum roll please....
Huh? What is frac sand? It's a durable, crush-resistant sand made with specific dimensions and qualities that is used by the energy industry to create proppant. This is a solid material designed to keep an induced hydraulic fracture open during or following a fracturing treatment. Annual proppant demand in the U.S. has risen from 17 million tons in 2009 to 46 million tons in 2013. In other words, sand is now a hot commodity.
Just how big can this business get? In 2013, management said frac sand has the potential to be as big an earnings contributor as its cement or wallboard businesses.
Texas and Illinois frac sand facilities
In fiscal 2013, the company opened its first frac sand mine in Corpus Christi, which is strategically located near the Eagle Ford shale play in Texas. However, the company does not have its own sand, and it is buying sand from third party vendors. It takes that sand and turns it into proppant. So the decision was made to expand its operations at its Illinois mine, which is near the Utica shale. This way, the company will have its own sand, making the production process vertically integrated and more profitable. The company is waiting on the permit, which should arrive later this month.
In the most recent quarter, the company had an operating loss for this business segment of $4.9 million, which was associated with the start-up of its new frac sand operation in Illinois. Once it is operational, the profits will start rolling in. Within two to three years, the company estimates producing 4 million to 5 million tons of frac sand. Both facilities have access to nearby railroads as well.
The frac sand business is "wildly profitable"
LaSalle County, Illinois is the capital of the frac sand world, providing unprecedented sand quality and deposits that are hard to find anywhere in the world. Yes, not all sand is the same. We are talking about silica sand here, also known as quartz sand. LaSalle County has the rare stuff that the oil industry wants.
Mining and aggregate companies have quietly bought at least 3,100 acres in LaSalle County since 2005, including 564 acres purchased by Eagle Materials. It has a long-standing relationship with Illinois Cement, allowing it to gain entry into this competitive market in a big way.
While the county has banned new sand mines, there is a way to get around the law by appealing directly to villages and towns that have the right to annex land and apply their own laws. Most sand mine operators have agreed to pay around 15-20 cents per ton to the city of LaSalle. That's right, 15-20 cents on $110 per ton. It is a fraction of one percent, while energy companies that do the actual fracking operations pay the state a tax between three and six percent.
Farmland prices sell for near the highest in the country, around $9,100 to $12,700 an acre. But farmers who sell their land to the mining companies can get nearly double. The median sale price has been around $17,500 an acre.
It's a good deal for the farmers and an even better deal for the miners, who are able to recover the costs in approximately two or three weeks once a mine opens. At $110 a ton, the company estimates the mine will generate $99 million a year (900,000 tons) over the next 45 years, the estimated life of the project. Analysts estimate that around $40 of the $110 per ton price is pure profit. The total costs for the company to open a mine? It spends $8 million to buy the land and expects to invest $25 million to $50 million to get the mine running. Not a bad return.
Carbo Cermanics (NYSE:CRR) is a leader in the frac proppant universe. However, there is a big difference. While sand and sand-based proppant like the stuff that Eagle Materials is selling is lower cost, Carbo sells the ceramic kind, which is higher cost and higher performance.
Fracking aside, Eagle Materials still faces intense competition with Vulcan Materials (NYSE:VMC) and Cemex (NYSE:CX). Vulcan is the nation's largest construction aggregate producer, and Cemex is one of the largest cement companies in the world. Both companies compete with Eagle's aggregate businesses, but neither is heavily invested in frac sand.
Fracking remains a controversial public issue, with uncertainties about safety and environmental impacts. Everything from water safety to earthquakes is being discussed. Frac sand operators are feeling political and social pressure. Fracking operators and frac sand producers are both being targeted. Recently, a Grant County Circuit Court judge issued an oral ruling saying a state board erred in denying frac sand permits near Bridgeport, Wisconsin. Erie County also voted 9-2 to ban fracking in its jurisdiction.
Eagle Materials is doing a lot of things right. Its core businesses are benefiting from the housing and commercial construction recovery, and the frac sand business is in the right place at the right time. The political and social headwinds will likely remain for quite some time. I would watch and see how the market responds to the frac sand businesses in Illinois, but given the recent spike in energy prices, it will likely be strong.