Sand and Water, the “Picks and Shovels” of Hydraulic Fracturing

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

All companies engaged in hydraulic fracturing need two basic things: water to fracture rock so as to release oil and gas, and proppants, particulates mixed in the water to keep the fractures open. The future looks bright for hydraulic fracturing as America’s demand for oil and gas relentlessly grows. Let’s see how investors can profit from water and proppants in the hydraulic fracturing world.

Total solutions for all your environmental disposal needs

Nuverra Environmental Solutions (NYSE: NES) provides water and waste water disposal for drill sites employing hydraulic fracturing. In addition to water related services, Nuverra also handles so-called “restricted solid” (a.k.a. government regulated solid), fluid and hydrocarbon waste products. That is, Nuverra offers drillers one-stop shopping for all their environmental disposal needs. Nuverra also serves the general industrial market with similar waste removal or recycling services, but the bulk of its revenues come from its hydraulic fracturing related business. 

This past quarterly report contained a mixed bag of results. The good news: revenues are rising, EBITDA tripled over the previous year, and the company forecasts better results for the back half of the fiscal year. The bad news: net operating losses widened compared to the previous year, and the company holds $567 million in debt compared to cash and equivalents of $18.2 million. Management acknowledges the first quarter of the year traditionally starts slow but maintains business will pick up as the year progresses.

One recent development of note involves the acquisition of a solid waste landfill in the Bakken oil play. As Foolish contributor, Matt DiLallo points out, this is a logical extension of Nuverra’s operations. Previously, Nuverra simply handled the logistics of removing solid waste; once the landfill comes online, Nuverra will also own the landfill that is the final resting place for this waste.

Sand, it’s not just for the beach

The homepage of Hi-Crush Partners (NYSE: HCLP) spells out its business best: “Hi-Crush Partners is a pure play, low-cost, domestic producer of premium monocrystalline sand, a specialized mineral that is used as a proppant (“frac sand”) to enhance the recovery rates of hydrocarbons from oil and natural gas wells. Our reserves consist of Northern White sand … and [it] is highly valued as a preferred proppant due to its favorable physical characteristics.”

Hi-Crush offers investors an opportunity to profit from both distributions and capital gains. The distribution offers immediate income of around 8.4%. The stock, while expensive at about 25 times earnings, boasts an array of impressive metrics, including a return on equity of 81%, a return on assets of 24%, a profit margin of 59% and quarterly earnings growth of 75% year over year. Hi-Crush looks like it has profited well from the hydraulic fracturing boom and should continue to do so.

While Hi-Crush looks attractive in many ways, the company warrants a measure of caution. Currently, Hi-Crush and Baker Hughes have locked horns in a legal dispute over Baker Hughes backing out of a contract. The litigation expense and lost Baker Hughes business will weigh on future earnings. To be sure, Hi-Crush learned from this experience and has modified other customers' contracts. How much this dispute will impact earnings remains to be seen.

US Silica (NYSE: SLCA) also provides proppants to the oil and gas industry. Its other business activities include providing silica sand products to the glass, chemical and construction industries. The oil and gas segment provides about 60% of US Silica’s revenues.

US Silica stock climbed from around $11 a share to over $21 a share over the past year. At about 15 times earnings, the stock is more attractively valued than Hi-Crush. US Silica also carries less debt than Hi-Crush. However, US Silica only pays a 2.3% yield, far less than its competitor. Further, while revenues have steadily grown, earnings don’t always follow, a worrisome sign. 

Two developments investors should look at: First, US Silica recently announced the opening of a new fracking sand facility near the Eagle Ford oil basin. Teaming up with railroad company BNSF, US Silica will be able to ship 10,000 tons of sand every two days to drillers working this oil play. Clearly, a good thing. Second, US Silica announced the sale of almost 12 million shares of its common stock from a private equity firm. While US Silica will not receive any proceeds from this sale, it could put downward pressure on the stock. 

Final Foolish Thoughts
Hydraulic fracturing requires as much as 6 million gallons of water and 2,500 tons of sand per well. This spells opportunity for companies supplying these products. Hi-Crush looks like the best all-around investment with its combination of high yield and growth potential. While selling at a higher earnings multiple than US Silica, Hi-Crush offers an inviting combination of immediate income and long term growth. Nuverra is the high risk/high growth stock of the bunch. Watch for improvements in operating income and debt going forward.

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Robert Zimmerman owns shares of Nuverra Environmental Solutions and has the following options: Short Jun 2013 $4 Puts on Nuverra Environmental Solutions. The Motley Fool owns shares of Nuverra Environmental Solutions and has the following options: Long Jan 2014 $4 Calls on Nuverra Environmental Solutions and Short Jan 2014 $3 Puts on Nuverra Environmental Solutions . 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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