Watching Emerge Energy Services' (NYSE: EMES) stock crush the market so far this year has been like watching an eclipse. The right conditions all seemed to align perfectly. With an emerging (pun intended) position as a leader in the sale of sand -- yes, sand -- Emerge Energy Services is setting itself up to be a major player in the oil and gas market over the next several years. Let's take a look at why something as simple as sand production has sent shares of Emerge Energy Services through the roof and whether it can maintain that pace further down the road.
The pulse of the oil & gas industry
Ever heard of a thing called fracking? Aside from being a political hot topic, the general association with fracking is that it is injecting water into a shale well to crack the reservoir and allow oil to flow. That is true, but it's only half the story. To keep those cracks open and the oil flowing, you need a proppant, the same idea as using a wedge to keep a door open. One of the most effective proppants that oil and gas companies have found is sand, and the industry is using a lot of it.
To give you a picture of the type of demand were talking about here, this graphic from Emerge's competitor, U.S. Silica Holdings (SLCA -2.27%), explains it best.
Source: U.S. Silica Investor Relations
The one thing that everyone understands it that total rig counts in the U.S. are increasing as more and more companies drill shale wells, but what is sometimes overlooked is that every other aspect that drives sand demand is increasing as well: Rigs are drilling more efficiently, lateral lengths (the horizontal section of a shale well) are increasing, companies are doing more fracking stages per foot of lateral, and they are using more sand per stage. Add all of these components up, and the average sand used per well has increased from 2,500 tons to 8,000 tons in a matter of a couple years.
Emerge's role in this developing trend is that it has not just a large amount of sand production capacity, but that sand is also a higher quality grade sand that can handle higher pressure environments without collapsing.
Source: Emerge Energy Services Investor Presentation
On top of that, the company also has major plans to expand its production with two new mines that will increase total output by one third and two new processing facilities that will more than double current capacity. The combination of a high demand sector with lots of room to grow, an industry leading-position in quality, and a massive uptick in production over the next couple years or so positions Emerge Energy Services as a premier sand supplier to the oil and gas industry.
Now, I would be remiss to not mention two other critical aspects of Emerge. The first is that sand isn't the company's only business segment. It also has what it calls a fuels segment that provides terminal storage, wholesale distribution, biodiesel blending, and transmix refining -- which is the separation of petroleum products such as gasoline and diesel that are transported in the same pipeline. This side of the business has shown its own signs of growth -- last quarter's EBITDA from the fuels segment was more than double its year-over-year results -- but it's completely separate from the sand business and needs to be accounted for when making an investment decision regarding Emerge.
The other aspect you need to know about Emerge is that it is a variable rate master limited partnership (MLP). What this means is that it pays out its distributable cash flow to investors to avoid being taxed at the corporate level. As a variable rate MLP, though, it will distribute 100% of its distributable cash every quarter instead of distributing a fixed amount determined by management. In some senses this is good because the company never pays out more than it can handle. The drawback, though, is that distributions could potentially be lower from quarter to quarter from operational weakness, and the company can't keep a little excess cash on the books to fund capital spending.
What a Fool believes
Shares of Emerge Energy Services are not cheap by any means. With a total enterprise value to EBITDA ratio of more than 30, you will have to pay a very hefty premium for an MLP that yields about 3.9% based on today's prices. Some may argue that the outlook for its sand and fuel segments is so strong that it's worth the premium, but personally I just can't get too excited for a company that expensive. Emerge looks like it will remain competitive for years to come, so it may not be a bad idea for a patient investor to have some cash on hand for when shares become a little less expensive.
