Carbo Ceramics: Ways to Play Proppant Sales

 |  Includes: CHGS, CODGF, CRR, STO
by: Michael Filloon

I first wrote on Carbo Ceramics (NYSE:CRR) on January 21st of this year. Since then, Carbo is up $62/share, give or take a few cents. It sells ceramic proppant to companies engaged in horizontal drilling. Proppant is used to "prop" open fractures in shale deposits. If proppant is not used, the fractures in the shale will compress and seal up. Proppant, resin-coated proppant, resin-coated sand and sand are all used to keep oil and natural gas flowing from shale. Carbo was up 14.91% today. It announced earnings of $1.30/share or $151 million in revenue. Expectations were $1.02/share or $130 million in revenue. Quarterly revenues were 21% higher then last year and it was the best quarter of Carbo's history. Sales volumes improved from a recently constructed, third manufacturing line. It quickly ramped up to full production upon completion. Revenues in the first quarter of 2011, increased 22% when compared to the first quarter of 2010. North American sales increased 11% in North America and decreased 8% in Europe. Operating profit increased 60%. This was caused by three variables:

  1. Higher Sales Volume
  2. Increased Average Sales Price
  3. Higher Contribution From Falcon Technologies

Net income increased 59% when compared to the first quarter of 2011. In the three months ended March 31 of 2010, Carbo sold 361 million pounds of proppant. Three hundred and seventy-six million pounds were sold in the three months ending March 31 of 2011. Other proppants such as resin-coated sand (CarboBond RCS) and API/ISO certified proppant increased sales significantly. In three months ended March 31 of 2010, Carbo sold 9 million pounds of other proppant and resin-coated sand. 23 million pounds were sold in the three months ending March 31 of 2011. The strong points of Carbo's first quarter were:

  1. The economic conductivity of Carbo Ceramic proppant in North American shales such as the Bakken, Eagle Ford and Permian continue to create higher IP rates and EURs.
  2. Carbo has two lines for expansion of proppant production. This will increase annual production capacity to 2.1 million pounds.
  3. Carbo's ceramic proppant and resin-coated sand are seeing good demand.
  4. Carbo's traceable, non-radioactive proppant is seeing increases in sales, specifically in international markets.

CEO Gary Kolstad stated the company expects demand to be robust through 2011. Proppant's positive economics in oil and gas drilling pays for itself. Demand is increasing for these reasons:

  1. Over 20% increase in IP rates
  2. Over 20% increase in EUR
  3. Rapid payout on initial investment

Proppant price increased between 7% to 9% this quarter. It is possible that these price increases will continue, as much of the oil service companies continue to have pricing power. Carbo tested its proppant versus a competitor's in the Haynesville shale. Carbo's proppant increased production by approximately 20% in the first 18 months. At $5 MCF, a revenue increase of $1.4 million over that time frame. In the Bakken, ceramic proppant was compared to sand. Proppant wells produced twice as much oil. Proppant wells in the Bakken increased EURs, eliminated flow back issues, and improved oil production rates. Ceramic coated proppant production will increase this year, as Carbo identifies demand. Carbo seems well positioned through 2011. If you would like a more in depth article please read "Carbo Ceramics: A Way to Play Shale Drilling."

Brigham (BEXP) has been vocal about its use of ceramic proppant. It use has increased production and EURs in Brigham's wells. It is difficult to ascertain how much it increased production, as Brigham has made several changes to how it drills for oil:

  1. Longer Laterals
  2. Smart Pad
  3. Ceramic Proppant
  4. Mobile Rigs
  5. More Stages

Brigham has made changes to become a better Bakken driller. Longer laterals and more stages lead to greater amounts of proppant needed. When studying the 56 Bakken wells Brigham has drilled in the Bakken, the wells drilled the earliest have much lower barrels of oil equivilent per day through 30 and 60 day time frames. Decreased stages have lower oil volumes. When Brigham is compared to its peers it also outperforms. Over the past five quarters Brigham has average IP rates that are between 89% and 118% better then its peers. Some of this is due to increased proppant usage. Kodiak Oil and Gas also reported a significant increase.

Carbo Ceramics has a very large market share in ceramic proppant. Saint-Gobain Proppants (OTCPK:CODGF) is the largest competitor. Saint-Gobain derives only a small amount of its total revenue from proppant. This company is diversified and not as levered to proppant sales. Competitors are located in Brazil, France, and China. One Chinese company may be the best way to play proppant. China Gengsheng Minerals (NYSEMKT:CHGS) is often mistaken for a rare earths producer. It has a refractory business, and also produces ceramic proppant. Carbo has stated increased demand has allowed price increases. It could be an opportune time to invest in a smaller competitor. In 2009, Gengsheng's percentage of net revenues were:

  • Refractories 84%
  • Proppant 14.1%
  • Industrial Ceramics 1.9%
  • Fine Precision Abrasives 0%

In 2010, these numbers were:

  • Refractories 73.6%
  • Proppant 23%
  • Industrial Ceramics 2%
  • Fine Precision Abrasives 1.4%

Proppant sales increased significantly from 2009 to 2010. CHGS sells to three companies in China:

  • China National Petroleum Corporation
  • Sinopec Shanghai Petrochemical (NYSE:SHI)
  • CNOOC (NYSE:CEO): Only signed provider of proppants for CNOOC

These companies have been customers since October of 2007. In April of 2009, construction of its second line of proppants was completed. This increased proppant production from 33000 metric tons to 66000 metric tons. The new production line adopted technology that decreased production costs by 10%. This technology also expanded Gengsheng's product line. It is now able to produce proppant that caters to oil companies, with variable well pressures. In 2009. CHGS sold 23700 metric tons of proppant. An increase in sales of 71% or 41270 metric tons was seen in 2010. Revenue in 2010 increased by 78.1%. Average selling price per ton increased from $340 per metric ton in 2009 to $347 per metric ton in 2010.

Its refractory business is in a competitive market, making it difficult to raise prices. If the economy continues to improve, this part of the business should grow. Its proppant business could grow exponentially based on the volumes at Carbo Ceramics and Saint-Gobain Proppants. CHGS has missed earnings for four straight quarters, but sports an estimated earnings growth of 333%. Estimated EPS for 2011 is 13 cents. This is an increase from 4 cents/share in 2010. CHGS is a speculative play, where large moves are common place, so be careful. If you are not interested in this type of investment, Carbo Ceramics is a well run business with continued upside. When looking at the numbers, the question isn't whether they can sell inventories, but can they increase production to meet demand.

Disclosure: I am long CHGS, BEXP.

Additional disclosure: Source: Brigham Exploration (BEXP) Source: Carbo Ceramics (CRR) Source: China Gengsheng Minerals (CHGD) Source: Kodiak Oil and Gas (NYSE:KOG) Source: Oasis (NYSE:OAS) This is a list of stocks engaged in proppant sales to the horizontal drilling industry. It is not a buy recommendation, as these names are a resource to help investors find investments in sectors or products that fit their investment strategies. These investments can decrease in value significantly as there can be considerable risk involved. Please study before makning any investment.