Emerge Energy Services (NYSE: EMES) burst onto the scene after completing its initial public offering in May 2013. Its units rocketed up from the $17 IPO price to nearly $150 per share before falling back to Earth a bit as the price of oil dropped.
Still, the stock is up well over 400% since the fuel processing and sand production specialist went public, as investors are buying into the company's frack sand-fueled growth. With investors paying up for this growth, let's make sure the company is spending enough money to deliver real growth.
When physics meets economics
One of the biggest hindrances to growth for any company is the second law of thermodynamics. That law basically says everything breaks down. This comes into play when a company, such as Emerge Energy Services, invests capital for a new asset, such as opening a new sand mine, in order to grow its business. That asset, thanks to the laws of physics, will slowly break down, so money needs to be spent to repair the resource just so it can sustain performance.
We see this at work all the time as businesses depreciate assets that are wearing down and will one day no longer be useful. Money invested to maintain a company's existing assets is typically referred to as maintenance capital expenditure. Any money spent above the cost of depreciation and amortization is capital spent to grow the business, and is therefore known as growth capex.
Following the cash
Emerge Energy Services is a fairly new company, so available data only goes back a couple years. I'm using data provided by S&P Cap IQ, studying depreciation and amortization on Emerge Energy Services' cash flow statements and comparing them to the capex spent to maintain these assets. Over the last three years those numbers look like this:
Data provided by S&P Cap IQ. Chart prepared by author.
We can see here that in 2011 and 2012 Emerge Energy Services spent more than enough capital to maintain its operations, as well as an additional $40 million in growth capex. However, in 2013, the company spent just enough money to maintain its business and did not invest anything on growth.
That would be a warning sign if it continued in the future. But by digging a little deeper into 2013 we find that while Emerge Energy Services only spent $21 million in capital to purchase property plants and equipment, which matched depreciation, the company also spent nearly $17 million on acquisitions.
Furthermore, Emerge Energy Services is investing to grow its business organically in 2014, especially its frack sand capacity. The company has two facilities under construction. As shown on the following chart, these assets are scheduled to come online in late 2014 and early 2015.
Source: Emerge Energy Services Investor Presentation.
In addition to these two announced growth projects, the company has the potential to acquire additional facilities, and reserves continue growing. Acquisitions are typically a key part of a master limited partnership's growth; these companies routinely invest a minimal amount of capital to maintain operations, with the bulk of future growth coming by either purchasing what are deemed to be noncore assets of a larger company or acquiring a smaller rivals' operations. This is exactly what Emerge did last year by spending $17 million on acquisitions while spending just enough in capex to match depreciation.
Clearly, Emerge Energy Services' growth isn't in trouble. The company spends more than enough money to maintain its operations -- its capex has exceeded depreciation over the past three years. This excess, when combined with capital spent on acquisitions, is fueling future growth. Given its outlook, Emerge has plenty of opportunities to invest in growth over the next few years.
