3 Pick-and-Shovel Plays for Shale

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Excitement continues to build over America’s possible energy independence, courtesy of shale energy production. Innumerable articles describe exploration and production companies, pipeline companies, and refiners. But a lesser-known category of stocks also stands to benefit from America’s booming energy production: the "pick-and-shovel" companies providing the hardware and equipment that energy producers need.

Diesel where the trucks are
Think about this.  Crude oil is extracted from Bakken shale in the Dakotas, shipped to a coastal refinery, made into diesel fuel ... and returned to the Dakotas to fuel all the trucks there. Why not make diesel fuel right where it's extracted?  

That’s what MGU Resources Group (NYSE: MDU) thought, so it teamed up with Calumet Specialty Products Partners to build a refinery in North Dakota. The state recently issued final approval to build the refinery, and construction should begin this month. According to the company, diesel fuel consumption in North Dakota grew 75% over the past four years, with no letup in sight.

This joint venture adds to MDU’s portfolio of businesses. Currently, the company operates a variety of endeavors, including regulated electricity generation, unregulated  energy ventures, and construction. Oil and gas production is the single biggest source of revenue, and will likely drive future revenues higher.

As a major electric utility in the Dakotas, MDU stands to profit from the growing population coming to work in the energy business. MDU’s pipeline business could also benefit from growing oil and gas production. Lastly, MDU’s construction division should thrive amid continued transportation building activity.  

Keep an eye on the 40% debt the company carries.  Much of that is capex to seize  business opportunities. MDU's smart to invest in the future, but you should monitor the company to insure that its investments pay off.

Water, water, everywhere -- but you don’t want to drink it.
Hydraulic fracturing revolutionized shale energy production, but the process leaves behind a lot of contaminated water.  Enter Heckmann (NYSE: NES).  

Heckmann (soon to be Nuverra Environmental Solutions) recycles or disposes of water after fracking.  It also collects and recycles oil-related waste products, antifreeze, and solid waste products from shale exploration sites.  In short, Heckmann provides clients with a single vendor to clean up hydraulic fracturing waste.

Recently, Heckmann completed a merger with the private firm Power Fuels, the largest environmental services company in the Bakken shale area.  Power Fuels grew about tenfold since 2007, and it should complement Heckmann nicely.  

Currently, Heckmann stock has been under pressure from declining natural gas prices and a large short position. But given the Power Fuels acquisition, I’m not sure selling short makes sense. Motley Fool analyst Matt DiLallo believes that the market thinks Heckmann’s business depends on shale gas exploration, whereas the company actually derives 70% of its income from liquids and oil plays.

Heckmann looks like an investment for those willing to wait for acquisition expenses to run their course. Once they do, this stock could pleasantly surprise the market.

And speaking of fracking fluid...
Sand and other proppants are an integral part of hydraulic fracturing fluid.  US Silica (NYSE: SLCA) supplies silica sand for this purpose. That means shipping the sand by its own rail, truck, or barge assets to all major shale plays in the US.

US Silica’s Industrial and Specialty Products division also supplies a diversity of industries, including glass, housing, and water filtration/ treatment. But the big story for US Silica clearly remains providing sand for hydraulic fracturing.

Founded over 100 years ago, US Silica went public on Feb. 1, 2012. The stock initially dipped, but came back strongly. The stock recently dropped again due to a large sale by a private equity firm. I anticipate another strong comeback.  

US Silica’s most recent earnings report showed that 2012 earnings per share increased 146% over 2011 earnings. CEO Bryan Shinn, in a conference call, mentioned that the company has turned away customers due to product shortages, a situation management's now trying to fix.

The company's earnings momentum, and the continued demand for fracking sand, suggests sustained profitability and earnings growth for U.S. Silica.

Final Foolish Thoughts

If you want a safe all-around “pick and shovel” shale investment, I recommend MDU Resources. Its diverse operations protect its revenues.  If you want a momentum growth stock, US Silica and its high-demand fracking sand and transportation infrastructure is for you.  And if you want a diamond-in-the-rough growth stock, Heckmann/Nuverra Environmental Solutions could be the ticket -- but not for long. Its most recent earnings report caused the company to pop 11% last Tuesday, suggesting that the market may have already priced in much of its potential.


Robert Zimmerman owns Calumet Specialty Products Partners. The Motley Fool owns shares of Heckmann and has the following options: Long Jan 2014 $4 Calls on Heckmann and Short Jan 2014 $3 Puts on Heckmann. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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