Emerge Energy Downside Priced In, Has Catalysts For A Major Recovery

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About: Emerge Energy Services LP (EMES), Includes: FRAC, PTEN, SLB, SLCA
by: Todd Akin

Summary

Emerge Energy has seen enough selling pressure, as now they trade at only 3x earnings, yet are expected to return to growth mode in 2019 once completions resume.

The frac sand provider did experience heavy pricing pressure on their NW volumes and idled 50% of their NW capacity.

The company also experienced construction delays on their local brown operations in San Antonio, and had to rely on third-party sales to honor volume commitments.

However, these issues are all transitory, and certain catalysts that I am about to list should help aid in a recovery for Emerge Energy's share price.

Emerge Energy (EMES) reported disappointing numbers this morning, posting revenues of only $63 million, and a net loss of $3.9 million. Despite these numbers being soft, they were widely expected, as most major industry players had already warned investors that completions would slow from exhausted budgets and lack of takeaway capacity. EMES faced other obstacles, though, including the idling of over 50% of their Northern white volumes, and construction delays on their San Antonio mine, which didn't exactly help investor sentiment.

However, since these issues are challenging, they are seen as transitory by the company, and negativity seems largely priced into the stock now. The company has also has a few catalysts to drive future earnings. As a result, investors who have stayed long the stock during one of the worst beatdowns in human history may be finally be seeing the light at the end of the tunnel for Emerge Energy.

Emerge Has Catalysts For A Recovery

Emerge is not the only services player to report slowdowns. Pressure pumpers like Patterson-UTI (PTEN) posted a loss in Q3 for the same reasons, yet shares popped. Keane Group (FRAC) was no different; they saw "white space" on their calendars like everyone else. Schlumberger (SLB) idled pressure pumping crews, as well.

The good thing about listening to Patterson-UTI's call, though, was that they gave investors new insight into the world of completions in the Permian, including new catalysts that should drive future earnings for Emerge.

The first thing Patterson (PTEN) mentioned was that despite seeing a slowdown in their completions segment, which adversely affects frac sand companies like Emerge, their drilling operations saw increased activity. This means more DUCs, which bodes well for Emerge when completions resume in early 2019.

The other major point worth mentioning from PTEN's call was the trend of zipper fracs (where two wells are fracked simultaneously at alternating stages), that are coming to the Permian. This is significant because almost half of all drilling takes place in that region. So, if more wells are drilled and completed using zipper fracs in the Permian, sand usage will increase dramatically to almost double per well, since two wells will be fracked at the same time now.

More Catalysts For Emerge

Besides the obvious catalysts in the San Antonio mine ramping by the end of November, and construction on their local brown sand mine in Oklahoma being targeted for completion in January, EMES said that they would realize new cost savings in a number of ways.

First, by upgrading from the more expensive power generation methods that they were using before, they can save a couple of more dollars per ton, adding to their contribution margin. They will also be able to reduce their reliance on third-party sand providers once construction is complete on their San Antonio mine at the end of this month. They will, however, still need feed sand for their Oklahoma mine until it is complete.

By the way, these third-party sand suppliers were needed, presumably, to fill the gaps in Emerge's local brown operations while construction was taking place. Perhaps they used a new local miner's sand who didn't have the contracts that EMES had. Maybe those third-party suppliers just had more sand available to the spot market, and made friendly price concessions to EMES. Whatever the case, that should be over and done with once Emerge's San Antonio mine is complete.

Last but not least, Emerge is in the process renegotiating contracts to address the volume shortfalls seen from their Northern White sand that are temporarily oversupplied. This will help offset weakness that is expected to be seen again next quarter. For the record, I don't believe volumes will be displaced permanently, judging by what HCLP said about their idled NW dry plant, since they expect it to resume operations once completions activity returns in 2019.

Conclusion

Emerge Energy is trading at only 3x earnings, while business fundamentals continue to improve. Debt has been reduced, assets have nearly doubled, and sand per well continues to increase at CAGR of about 10% per year. All issues holding back the company right now are transitory, and are expected to be resolved by 2019.

EMES also has catalysts to aid in its recovery, including DUC counts building, zipper fracs coming to the Permian, upgrading utility costs, eliminating third-party frac sand reliance, and recovering volumes lost through renegotiated take or pay contracts.

Something else to keep in mind is that, while volumes decreased significantly from over 50% of their NW capacity being idled, brown volumes will take the place of the displaced NW, and offer more attractive margins than NW in the first place since there is less overburden associated with local brown sand mines.

Pricing should also remain strong on those in-basin volumes, which HCLP and U.S. Silica (SLCA) confirmed was the case. This means that a serious price dislocation is occurring with shares, since the stock's devaluation was devalued on pricing fears in the first place. I don't want to get overzealous, but saying that investors could catch a double from these embarrassing $2.00 levels is an understatement. For all of these reasons listed, investors who have toiled and stayed long Emerge have plenty to look forward to, and may finally be on their road to redemption.

Disclosure: I am/we are long EMES.

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.