Smart Sand (SND) reported 3Q earnings today that were better than expected since NW pricing was quoted to actually have risen to around $53. This was due to a higher percentage of sales moving in-basin, where pricing remains strong.
Revenues were $63.1 million and net income was $12.1 million compared to $10 million net income in the previous quarter. So, clearly, the company's fundamentals are not declining and actually, seem to be improving quarterly despite challenging market conditions concerning pipeline availability.
But, the most insightful part of the Q3 call was on the transport of local sand and gradation issues of Northern White sand. This has bullish implications for NW sand providers like Hi-Crush Partners (HCLP), U.S. Silica (SLCA), Covia (CVIA), and Emerge Energy (EMES), which we will discuss further below.
SND Confirms Moving Sand Is Not That Easy...
Smart Sand management described how the trucking of local sand was not a viable option in the long run and that rail was the best way to move sand on the recent Q3 call.
Smart Sand management stated on the call that not only is a train the way to move NW sand but also if the sand is not on a unit-train, in particular, then that is a problem. Again, sand needs to be moved on a unit-train, not trucks. Sand is heavy. Really heavy. Why do you think it is used as an anchor to weigh things down and block heavy pressure?
So, moving it is sort of easy in theory, I suppose, if you have the network. But it is very expensive (rail costs add $50 to price per ton of sand). This is why E&Ps have chosen trucking in the Permian as the way to move their sand since it is local brown sand that is closer by anyway, unlike NW. However, E&Ps are starting to see that trucking sand really is becoming a huge problem for them.
This plays into the hands of Smart Sand who has extensive unit-rail capabilities. Owning rail cars is expensive and so the venture involves risks. But, if they are all out of storage, then fixed cost absorption begins when volumes of sand increase. In other words, unit-trains further reduce costs through carrying substantial volumes, and this is the method of delivery for many public frac sand companies like SND.
So, if rail does indeed become understood by E&Ps as the better option to move sand, combined with decline issues Permian sand is reportedly having, then E&Ps in the Permian could be lining up to SND's doorstep since they have the rail networks and Northern White sand to do the job.
Cost Savings For Trucking Eroding
Smart Sand's management also stated that anyone who thinks using trucks out there in this current fashion will work, is insane. Yes, read the call.
He said that a lot at a frac sand conference in Houston a while back, and he definitely has not changed his tune. In fact, this is one reason why they won't build out their local brown sand acreage in the Permian.
This has been an issue in the past for investors of Smart Sand who wanted them to build-out their Permian sand. However, SND not only needs contracts to go ahead with the mines but also someone to show them how trucking sand in the crowded Permian will work in the long run.
Obviously, brown sand would add substantial margins and revenues, but only if the pricing is there to do so. If more entrants come into the Permian, then trucking costs could rise due to shortages and traffic, while sand pricing falls, causing problems SND supposedly doesn't want to encounter.
As more and more trucks hit the streets, many of these smaller, two-lane roads in the Permian are seeing congestion issues. So, now the savings for using trucks are beginning to erode. Plus, when you factor in decline rates for brown sand, which are a definite issue, then savings for brown start to look like a joke.
Hi-Crush and others that do have brown are selling to E&Ps that don't care as much about decline rates and are more worried about costs upfront. However, if the savings for switching back to NW are indeed there, due to transport problems and decline rate issues, a huge shift could occur that could make NW pricing soar again. This event would have a positive impact on SND's contribution margins.
Gradation, Gradation, Gradation
I have stated in the past numerous times (as has management) that many grades of sand are used in fracking, and this, in addition to its higher quality and proximity to northern shale basins, is why Northern White would always have a home.
Because of the 80/20 rule, where most local brown sand is 100 mesh (80%) and the other 20% remaining are coarser grades and 40/70, Northern White coarse grades will be needed to fill the gap.
But what I found out on this call was that many newer, Northern White sand mines built in 2014 don't have the finer 100 mesh sand needed for fracking these days. The trends have evolved.
This means that while some NW sand pricing may be seeing softness, particularly with the coarse grades, finer grades like 100 mesh may be seeing stronger pricing. This also caters to SND's strengths since 100 mesh sand comprises a large part of their business.
As far as the remaining coarse grades go that have weaker pricing, Emerge Energy did say that more coarse grades are starting to be demanded, so this could help improve coarse grade pricing in 2019 as well.
Smart Sand reported strong numbers despite having to operate in a difficult environment where completions have slowed due to lack of pipeline capacity and constrained budgets. These issues are expected to be transitory and resolved in 2019.
In-basin pricing was also confirmed to be strong by Smart Sand, even in the Bakken and Marcellus, since Northern White sand is being sent to their terminals located in those basins. NW sand is essentially considered regional sand, anyway, since it is near those shale basins as Carbo (CRR) recently stated.
This is why in-basin pricing will remain strong, for both NW and brown sand. Any sand out-of-basin, where trucks are not used, has to be railed. This event completely displaces NW if there is not a lower cost way to move it via rail. Sand miners need to have easy rail access from the dry plant and multiple rail lines at that. Many NW and local mines, as Emerge Energy recently stated, are situated further away from in-basin activity or points of dual rail access, which will make them have to idle more tons since they are HIGHER COST.
Since Smart Sand has a brand new renovation done to their Oakdale facility and is a fully-integrated frac sand provider that can offer last mile services directly to the wellhead, costs should not be as much of a factor for them. Therefore, as demand in their end markets remains strong, particularly in northern shale basins, SND should be able to maintain their market share over peers.
As far as transport, decline rates, and gradation issues go (80/20 rule and lack of 100 mesh white available), these could have major implications on NW pricing and accelerate SND's earnings growth. Emerge Energy also said on their Q3 call that some local brown is starting to be idled, too. So, maybe this is the start of the trend, and Smart Sand has been right all along.
Time will tell. Smart Sand announced a buyback program stating that they believe share prices are not reflected accurately in today's marketplace. I agree and will continue to add to frac sand providers around the lows as a result.
Disclosure: I am/we are long HCLP, CVIA, SLCA, 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.