Is 50% Enough for Hi-Crush?

Take my word for it: Oil industry fundamentals are still bearish.

Take my word for it again: Price often influences fundamentals.

If the price of oil keeps going down, it should — SHOULD — help shift the supply/demand fundamentals closer to equilibrium. (If there even is such a thing!)

I think $43 per barrel is a good target for an oil price bottom. That might get people questioning:

• The capacity for producers to produce more oil, and

• The likelihood that consumers will meaningfully draw down bloated inventories.

But I could be wrong.

Rebalancing fundamentals might come down to a matter of time rather than price at this point.

So, in the meantime, it makes sense to consider how to smartly play oil in the other direction as the bottom-turn materializes.

Since I think it is too early to turn bullish on oil, let’s leave price alone. Let’s consider producers, equipment and service providers and refiners. (Or upstream, midstream and downstream, if you’d like.)

There are a host of producers I can get behind once the tide starts to turn. And there are certainly midstream companies poised to benefit from connecting the producers with the refiners. But today I want to bring your attention to a company that services producers before they’ve pumped the oil.

I Have a Crush on Hi-Crush

I’ve read many stories about major, integrated energy companies getting in on the shale oil revolution. Royal Dutch Shell (RDS.A), for example, is working its way into the prestigious Permian Basin. They’ve announced how they’re drilling 5 wells per pad rather than 1 per pad. This can reduce the time it takes to relocate drilling rigs.

What goes unspoken, though, is what this and other recalibrations mean for operations.

More wells mean more fracking … and more fracking means more sand.

Frac sand.

Frac sand is silica that props open the natural cracks and fissures in shale rock to allow gas and oil to escape.

This sand popped up on investor radar screens during the oil price downturn. That’s because shale drillers were forced to seek out ways to maximize production while minimizing cost. This meant, among other things, producers would need to maximize the production of existing wells rather than drill new wells.

Using more sand per well was one way to get more oil out.

But sand demand may have increased too much too fast. Some question whether sand supply will keep up if producers ramp up production in response to rising oil prices.

The need for sand in 2018 is expected to be double the need for sand in 2014.

Here is a good chart from the Wall Street Journal.

Another reason for the supply threat, besides increased frac sand proportions, is the fact that sand companies pulled back a bit on production since, overall, activity had dipped during oil’s bear market.

Two of the top producers are U.S. Silica (SLCA) and Hi-Crush Partners (HCLP).

Both are making moves to merge with and acquire key sources of frac sand. And both are positioned for what looks to be a revival in overall industry demand for sand as producers increase both the proportion of sand they use as well as the number of new wells they intend to bring online.

But I favor Hi-Crush because I like their name better.

Just kidding.

I really like Hi-Crush because its share price is still 75% off the high mark it set before oil hit rock bottom.

I like Hi-Crush because short interest — positions taken with expectations of further declines — represent 40% of daily trading volume. I see that as a contrarian indicator that makes HCLP ripe for a short-squeeze that could position the stock for a resumption of its longer-term uptrend.

I like Hi-Crush because its recent decline has retraced 50% of its bull market. (Compare that to a 31.8% retracement for U.S. Silica’s share price.)

In shorter time frames, I like to see 61.8% retracements before I feel a trade is "due" to resume its trend. But in this longer time frame, I think a 50% retracement could prove sufficient for an extension to begin.

Such an extension would mean HCLP roughly doubles to $34 from its current price of $17.

I also like Hi-Crush because it pays no dividend — it has no yield.

Wait — what?

Hi-Crush Partners is a limited partnership. Most limited partnerships distribute cash to its unitholders (shareholders). But Hi-Crush suspended its distribution several quarters ago "until further notice."

It’s not that I like that Hi-Crush doesn’t distribute cash. It’s that I like the fact that it will … eventually. And that’s going to add to the appeal … eventually. Here’s a blurb I grabbed from Barron’s:

Last year, [HCLP’s] distributable cash flow was negative. For this year, the consensus estimate on Wall Street stands at $92 million, followed by $257 million for next year and $355 million the year after. The consensus for next year’s cash distribution is $1.20 per unit, but that’s based on an average of individual estimates, some of which are zero. Even $1.20 per unit would give units a yield of over 8%.

In other words, dishing out $1.20 per unit would amount to a dividend yield of around 8%, depending on unit price fluctuations of course, for investors holding units of HCLP.

Chances are, you want to be positioned in units of Hi-Crush before it reinstates its cash distribution and its unit price takes off like a rocket … eventually.

Do right,
JR Crooks

Your thoughts on “Is 50% Enough for Hi-Crush?”

  1. I love the frac sand space, too. I had 20K in each of the big four sand producers…but during the latest fall, I admit I’ve gotten a little nervous-so I’ve reduced to smaller sizes. I was bullish as all heck until they announced more sand expansions (which was good, at first). But now, I am scared too much supply is coming from elsewhere. Look at what Preferred sands is doing in San Antonio. Also, I thought the sand was hard to find…but it seems now that everyone is finding sand in places besides Wisconsin. Your thoughts on my supply worries? Thx!

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“JR” specializes in trading commodities, currencies and options. He has spent nearly 10 years analyzing financial markets and writing about global economics. JR honed his trading techniques and global-macro worldview alongside his father, Jack Crooks, at Black Swan Capital. JR also…