Hi-Crush Inc.: Uncertainty Should Soon Vanish

Jan. 23, 2020 9:33 PM ETHi-Crush Inc. (HCRSQ)29 Comments

Summary

  • Hi-Crush has been on a wild ride in recent months, driven by oversupply in its space and low barriers to competition.
  • Though the company has been hit hard, management is forecasting positive free cash flow next year, but fourth-quarter news will give us a better understanding of its path forward.
  • The company is benefiting from a diversified set of operations, and this should prove accretive long-term.
  • Looking for a helping hand in the market? Members of Crude Value Insights get exclusive ideas and guidance to navigate any climate. Get started today »

The past year or so has not been particularly kind to shareholders in frac sand player Hi-Crush Inc. (HCR). Shares of the business have been crushed by persistent pessimism, ranging between concerns that in many parts of the US drilling activities are decreasing, combined with a well-known oversupply issue in the industry. The sad truth for these players is that these conditions are likely to remain like this for some time, and with the cost of adding new sand facilities incredibly low, any recovery would probably be temporary in nature. That said, the demand for frac sand will always exist, and by dipping their toes into other opportunities tied to this space, players like Hi-Crush can position themselves as attractive long-term prospects.

Recent developments and expectations

Anybody who follows the frac space closely doesn’t need to be told that the conditions stink. To see this, we need only consider recent performance by Hi-Crush. In the image below, for instance, you can see select financial and operational performance reported by the firm over the past few quarters ending in the third quarter of its 2019 fiscal year. In the third quarter, you can see that volumes delivered were actually pretty stable. This isn’t surprising, since global oil demand rises in the third quarter compared to the first and second quarter of most years - usually by a lot. That said, not everything was upbeat.

*Taken from Hi-Crush Inc.

As the table illustrates, the average price per ton for frac sand took a beating. During the quarter, it averaged only $43 per ton. This compares to $47 per ton just one quarter earlier and is down from the $64 per ton seen the same time last year. This represents a sizable decrease from the prior quarter. This, in turn, had significant ramifications for the contribution margin per ton for the company. Sequentially, the figure dropped by about 20% to $10.99.

Some investors may see this as a short-term blip on the radar, but it’s likely that the picture will improve materially absent a surge in drilling demand. As the graph below illustrates, monthly drilling activity in major US oil and gas basins has been on the decline. Yes, completion activity has been more or less level, but the total number of DUCs (drilled but uncompleted) wells has been falling. This is, long term, a negative for firms like Hi-Crush because it suggests reduced future activity at least for a while. Management seems to be aware of this. They have not provided specifics, but they did state that investors should expect continued weakness through at least the first quarter of the 2020 fiscal year. For the fourth quarter, for which management will release data on February 14th after the market closes, the expectation is for sales volumes, average price per ton, and contribution margin per ton to fall versus the third quarter.

*Created by Author

The key is diversification

Though it may not seem like there’s much ability for a frac sand firm to diversify its operations, the opposite is actually true. At this point in time, management is allocating its resources toward not only its core operations, but toward other business opportunities as well. One initiative under development for a while now has been Hi-Crush’s Last Mile program. Run through an entity called Pronghorn, the service permits the company to provide on-demand frac sand delivery to customers. Instead of ordering in bulk, receiving delivery, and then having to find a place to store the bulk sand, Pronghorn delivers containers and even its NexStage silo system by trucks and places them in optimal locations near drill sites. As of today, Hi-Crush boasts that Pronghorn now has a presence in each of the major basins in the US.

*Taken from Hi-Crush Inc.

Pronghorn is one avenue for diversification, but it’s not the only one. Management is always playing with asset leasing and, perhaps more interesting, its PropDispatch Software. The latter of these displays on-pad and in-transit inventories, provides volume delivered estimates, and eliminates or minimizes trucking demurrage. The system keeps track of dispatching requests, monitors real-time truckload deliveries, and simplifies back-office truckload reconciliation. There are other interesting features about PropDispatch.

The pessimist may argue that while these are technically ways for management to diversify the company’s business model, it’s still tying the firm’s fate to the frac sand space. That’s entirely fair, but the more valuable the company makes itself to firms, the more likely it is to receive work. Add to this the fact that demand for frac sand will not disappear entirely, and the company is making a wise bet on the future of the oil and gas industry within the US. This does not mean that everything will go smoothly though.

If you look at the first three quarters of the company’s 2019 fiscal year and adjust its figures by eliminating changes in working capital, the operating cash flow generated by Hi-Crush during that nine-month period would have been $29.76 million. Management did spend money on both maintenance capex and growth capex, but if you ignore growth capex (because it’s completely voluntary and should be accretive), then capex during this period would have been $18.71 million. This translates to free cash flow in the first three quarters last year of $11.05 million. Even if the fourth quarter is a wash, shares of Hi-Crush would be trading at a price/earnings multiple of 7.9 and at a price/operating cash flow multiple of 2.9. We will see where fourth-quarter results come in at, but this picture so far is encouraging.

One big downside for Hi-Crush (really the only material downside) is its amount of debt. According to management, the company ended the 2019 fiscal year with $57 million in cash and cash equivalents. If this is true and if debt remained unchanged from the third quarter, then net debt stands at $400.62 million. This is quite high, but on the plus side, management said that in 2020 it intends to spend just $25 million on capex (mostly on maintenance capex probably), and that, as a result, it intends to be free cash flow-positive. The extent of this positive cash flow is the magic question we need to keep an eye out for, but the more management continues to diversify away from the company's core business and toward ancillary services, the more likely it will be that the firm can weather the tough periods.

Takeaway

On the whole, I like Hi-Crush and believe the company offers investors with attractive prospects long term when you consider where it is currently priced. High debt does need to be watched, and management would be wise to reinvest its suggested free cash flow toward reducing this and maybe buying back stock, but the key to making sure this is possible is ensuring that management’s expectations turn out to be correct. That is why, when management does go to report financial results for the fourth quarter and elaborates on its thoughts for 2020, the biggest item shareholders need to watch out for is whether the business believes in positive free cash flow moving forward at that time. If so, the low share price the company is trading for could help to make it a truly wonderful investment prospect.

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This article was written by

Daniel Jones profile picture
24.64K Followers
Robust cash flow analyses of oil and gas companies

Daniel is currently the manager of Avaring Capital Advisors, LLC, a registered investment advisor that oversees one hedge fund, and he runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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