The value of last mile logistics. Contracted volumes. Ever increasing demand due to sand intensity. Frac sand investors were sold a heck of a great story, one that many bought hook, line, and sinker. The actual reality that bore out in results in recent years has been much different. While the Shale Revolution would not have been possible without frac sand, it turns out that all the hoopla on fancy sand mixes turned out be close to hogwash; the local stuff turned out to be good enough for upstream tight oil production firms. Similarly, it turns out that (surprise) sand is just not all that rare. While the industry demand still is forecast to be 110 million tons this year – only down incrementally from 2019 levels – there is still more than 200 million tons of active nameplate capacity sitting out there in the market, not including many other projects that have been shut down or curtailed but are sitting on reserves. In the Permian alone, there is more than 85 million tons of in-basin local sand capacity, outstripping demand by 100%. It is not just the Permian; in-basin mines have become incredibly common in the Eagle Ford, Haynesville, and Mid-Continent (SCOOP/STACK plays).
The revered Northern White has thus fallen out of favor. Once thought to lead to clogged oil wells, in-basin sand continues to see massive use in major production basins with little (if any) impact to well results. Shale’s focus on costs and ability to make good with lower end products surprised nearly everyone in the industry. Levering themselves to the hilt in good times, the bad times are officially here for publicly-traded frac sand and proppant plays.
- Emerge Energy Services (NYSE:EMES) filed for bankruptcy in July of 2019, and while the units still trade out there as the case works its way through the courts, holders of the common units in the limited partnership will not receive any distributions or retain any property as part of the current plan.
- CARBO Ceramics (OTCQB:CRRT) started the Chapter 11 process, clearing the way for the Wllks Brothers to take control of the company via a debt to equity exchange; shareholders will be wiped out in the process.
- Smart Sand (SND), which held its initial public offering (“IPO”) late in 2016 and commanded a market cap north of $500mm, is 95% off the post-IPO highs. The company gave a going concern warning as part its third quarter 10-Q but resolved that via an asset-backed facility against its equipment. Smart Sand has always run the most conservative balance sheet in the space, and while it is expecting see free positive free cash flow this year, worries remain over the impact to earnings as contracts roll off (currently benefiting from minimum volume commitment/shortfall payments). A large portion of the company’s accounts receivable – now $60mm – relate to a shortfall payment with one customer who has refused to pay. A negative outcome here could harm the outlook.
- Hi-Crush (HCR) continues to circle the drain. After an outright abusive general partner simplification, the company is paying the price for paying out 100% of earnings during the good years. The company reported EBITDA of $7.2mm in Q4, less than its quarterly interest obligations. The 2026 bonds (CUSIP 428337AA7) trade at fifteen cents on the dollar, having done nothing but head down since their issuance in 2018. EBITDA estimates for 2020 and 2021 stand at $30mm and $25mm, respectively, so the company will continue to burn cash given the market outlook. Investors have to be willing to pay more than 15x EV/EBITDA for the coming two years, betting on a future turnaround that might never arrive.
- U.S. Silica (SLCA) has its own problems. Amazingly enough, management was able to finagle itself into a Credit Agreement that has no leverage covenant on the Term Loan portion, a strong positive as leverage will spike above 7x by the end of 2020 (from 4.3x at year-end) on a trailing basis. The firm has to achieve positive free cash flow, as using the Revolver as a source of cash (beyond $30mm) triggers covenants that the firm would be in violation of. Investors here just have to sit back and hope for a better environment, but unlike many of the names above, it does have time.
Over the next two years, the majority of companies in this industry will have filed for bankruptcy. Any that do survive will never see equity values recover to post-collapse highs. It did not have to be this way, and the industry ended up in this spot via largesse and missing clear signs of change in their industry.
“The demand for frac sand is insatiable and that in-basin supply is needed to meet – and it doesn’t even meet the growing demand. So even if all of it came online, which we’re confident it won’t, that there still would be an undersupply of sand for the market.”
Robert Rasmus, CEO of Hi-Crush, Q1 2018 Conference Call
“So, you’ll see some onesies and twosies pop up [in-basin mines], but we don’t see anything like the Permian Basin eventuating in many of the basins today. We’ve looked ourselves in some of the basins, and the struggles you run into is that the quality of the sand is pretty poor in a lot of the basins, and also the well density is not sufficient to support a mine operation. So, you’d have to have kind of multiple small mines scattered all around even if you could find the sand, which is pretty difficult.”
Bryan Shinn, CEO of U.S. Silica, Q2 2018 Conference Call
“So the market is tight, and all in all we’ve got well over 70% of our sand contracted moving forward, which is about where we want to be given the opportunity to sell spot market in this very high-demand environment. We want to have some spot market available for premium price opportunities.”
Rick Shearer, CEO of Emerge Energy Services, Q1 2018 Conference Call
The Takeaway: Always Have Healthy Skepticism
Some might try to pin the blame on factors “out of management control” like COVID-19 or the collapse in oil prices, but those issues just accelerated the collapse. Frac sand was circling the drain long before these black swans emerged.
For years, there was perhaps not a more bullish group of senior executives than those in frac sand. They hit the energy conference circuit hard, were active with the press, and sold the Wall Street analysts on the economics. Anyone that criticized the industry or pointed out issues was quite often met with scorn (remember Dan Loeb / Third Point vitriol).
Some of the worst blow-outs I’ve tracked or followed over the past couple of years, within energy or other sectors, often come back to investors taking management statements as gospel. Being a successful investor requires a penchant for independent thinking and skepticism. For those that got involved in frac sand, it might have been a painful lesson, but it is hopefully not one they will repeat in the future.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.