The last six months have seen oil prices crash 40% to their lowest levels since the financial crisis. This has resulted in a massive decline in proppant (frac sand and ceramics used in fracking) suppliers such as US Silica Holdings, (NYSE:SLCA), Hi-Crush Partners, (NYSE:HCLP), Emerge Energy Services (NYSE:EMES), and CARBO Ceramics (NYSE:CRR).
Warren Buffett is famous for saying, "Be greedy when others are fearful." Well it's obvious that now is a time of pure terror when it comes to energy investments, so let's look at three reasons you may want to consider these high-yield stocks as part of your diversified income portfolio.
Historically Cheap Valuations
|Company / MLP||PE Ratio||Average Historic P/E Ratio (since IPO)||P/Operating Cash Flow||Historic P/OCF||FCF Yield|
|US Silica Holdings||11.5||17.6 over last 4 years||8.7||12.8||3.70%|
|Hi-Crush Partners||10.5||20.3 over last 4 years||9.9||18.3||4.50%|
|Emerge Energy Services||12.5||48.3 over last 3 years||9.8||10.9||1.40%|
|CARBO Ceramics||10.8||23.8 over last 20 years||6.2||18.1||NA|
As this table shows these proppant suppliers are now trading at deep valuations to not only the market and their industry average, but also their own historical valuations. In fact, on a P/E and price to operating cash flow basis, they are trading at historical discounts of 35%-74%, and 10%-66%, respectively.
You should be aware that since Hi-Crush and Emerge Energy are relatively young MLPs, their historical averages include a time of massive over-valuation, which inflates their historical figures. However, the free cash flow yield, which measures free cash flow (cash flows into the company after all expenses and growth investments are accounted for) divided by enterprise value (the value of the firm's business) indicates that US Silica and Hi-Crush Partners are currently trading at attractive valuations.
Strong balance sheets mean these four companies can survive the Oilpocolypse
|Company / MLP||Current Ratio||Quick Ratio||Interest Coverage Ratio|
|US Silica Holdings||3.33||2.59||9.21|
|Emerge Energy Services||2.07||1.43||13.2|
|CARBO Ceramics||4.5||2.07||no debt|
Another important factor investors may want to consider when deciding whether or not to invest in these companies is the strength of their balance sheets. With oil prices collapsing so fiercely, it's important to know whether any of these companies may have financial difficulty paying their short-term obligations. A good way of quickly checking a firm's financial stability is with the current, quick, and interest coverage ratios.
The current ratio measures a company's ability to pay its short-term obligations with current assets, while the quick ratio is more conservative, dividing a company's liquid assets by its short-term liabilities. A ratio greater than one tells us a company is on sound financial footing and, as the table above indicates, all four proppant suppliers should easily be able to provide for their immediate needs.
The interest coverage ratio measures the last 12 month's operating income divided by the trailing-12-month interest expense, and again, all of these companies are well able to service their debts. That should give current and prospective investors confidence that even should oil prices collapse further or remain low throughout 2015, none of these companies are likely to need new capital infusions or take on additional debt to keep operations running.
Generous and safe yield
|Company / MLP||Yield||Dividend / Distribution Coverage||Projected 5-Year Dividend Growth Rate|
|US Silica Holdings||1.80%||4.48||40%|
|Emerge Energy Services||12.1%||1.1||46.70%|
As seen in the above table, both US Silica and CARBO Ceramics, as the two lowest yielding proppant suppliers, are well able to support their dividends though strong payout ratios (presented here as a dividend coverage ratio). The two MLPs, Hi-Crush and Emerge Energy, may appear less safe; however, it should be understood that any distribution coverage ratio of greater than 1.1 is generally considered safe and able to support distribution growth in the future.
Note that despite the recent oil price decline, Wall Street Analysts are still expecting all four companies to strongly grow their payouts over the next five years. While these are only estimates and should thus be understood to be educated guesses (which may decline in the coming quarters if oil prices remain low) there are two reasons to believe these proppant companies will be able to grow their payouts even in a world of cheaper oil.
Long-term contracts and continued oil production growth protect the payouts
The first factor is that, according to Enterprise Products Partners -- America's second largest oil and gas pipeline operator -- U.S. oil production will still rise over the coming year, just slower than previously expected.
Part of the reason U.S. oil production has been growing so quickly is because of improved fracking techniques, such as increased frac stages, closer spaced wells, and increased use of frac sand. According to the Energy Information Administration, the average production per well has quadrupled over the last four years, partially because of the more than doubling of frac sand per well from 2,500 tons to 5000 tons. In fact, US Silica has reported that some of its clients are pumping 8,000 tons of sand into each of their wells because they've found that the more sand they use, the higher their ultimate oil and gas recovery rates.
Thus, it's possible oil and gas producers may turn to proppant suppliers as a relatively cheap way of boosting production, because the cheaper price of oil means that maximizing profitability per well is all the more important.
Also, even if oil prices were to remain low and drilling activity were to slow, US Silica, Emerge Energy, and Hi-Crush Partners all have the vast majority of their capacity accounted for in 2015 and beyond through long-term contracts. US Silica is sold out of its capacity until mid-2018, Hi-Crush Partners has 88% of its 2015 capacity under take or pay contract, and Emerge Energy is the best protected of all, with 87% of its 9.4 million tons of capacity (including expansion projects under way) under contract through the first quarter of 2019.
Bottom line: Now is the time to dive into these frac sand shares
The simple truth is that the best time to buy great companies for the long term is when there is blood in the streets and others are racing for the exits. Well, these four quality proppant suppliers, the pick and shovel makers for America's shale oil and gas revolution, are now thoroughly bloody. With these companies now at historically undervalued levels, and yielding more than triple the market's payout, I think now is the time for investors to snatch up shares of US Silica, Emerge Energy Services, CARBO Ceramics, and Hi-Crush Partners for the long term. Their strong balance sheets combined with several years of highly profitable contracts in place and secure payout coverage ratios increases the probability that these firms should be able to weather the current oilpocolypse just fine -- while hopefully generating large capital gains and income in the years ahead.