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A Juicy Dividend And Huge Growth. But What Are The Risks?

|Includes: Hi-Crush Inc. (HCR)

Late this summer, I was running a screen on high dividend stocks when I stumbled across Hi-Crush Partners LP (HCLP). HCLP is involved in the business of supplying fracking sand to oil companies. I thought to myself, "What the heck is fracking sand?" I conducted an internet search for fracking sand; the first article I found had a title akin to, "Fracking Sand: The New Gold"

All sorts of thoughts began to waltz through my head.

"Sand is gold?!"

I've got a nice stream that courses across my property, and the whole channel it cuts through is several feet deep in sand. "Sand! It's gold now! Sand is gold!" I ran a quick check of gold prices which were somewhere around eleventeen hundred dollars an ounce. I rushed to my window and looked down at our shimmering little stream in the distance and gasped, "There must be thousands of pounds of sand down there!"

I ran into my garage and grabbed one of the shovels hanging on the wall, started my truck and was backing out of my garage headed towards my new sand mine. Just as I was backing out, my wife pulled up in her car.

She bent down so she could see me through the passenger's window. "Where ya going?" she asked in her pleasant, sweet little way.

"The stream! The stream! There's gold in our stream!"

"What! There's gold in our stream?!" My wife looked confused.

"Yeah, fracking sand is the new gold!"

(If you've read my articles, you know my wife has several post-graduate degrees. One of my sons is in pre-med and another is studying to be an Astrophysicist. I have two kids in their mid-twenties that aren't in college because one is running a bank and another a large business. If my house was a shed, I would be the dullest tool stored within.)

My wife rolled her eyes and suddenly appeared exhausted. "Honey, what makes you think the dirt in our creek bed is fracking sand?"


Obviously, fracking sand is used in oil drilling operations. Fracking sand is a durable, rounded sand containing high-purity quartz. The sand's aforementioned characteristics serve to prevent fractured rock from collapsing back onto itself while at the same time allowing liquids to pass through and flow into a well. Ceramic beads, sintered bauxite and small aluminum beads are used as substitutes for fracking sand.

Fracking sand ranges in size from 0.1 millimeters to over 2 millimeters in diameter; however, most of the fracking sand consumed by drillers is between 0.4 and 0.87 millimeters in size.

It should be noted that operations are largely suspended during periods when freezing temperatures prevail due to certain processes required in the production of the product.

In other words, fracking sand can't be found just anywhere, like in the stream bed flowing through the back of our property.

(Information for this portion of my article was gleaned from What is Frac Sand? For more in depth information regarding the subject, refer to that article.

There is controversy concerning the health effects surrounding the mining and use of fracking sand. I will not pursue that path aside from informing investors that those concerns exist and could conceivably affect your investment. However, point/counter-point articles addressing those concerns can be found in two Forbe's aricles: ProPublica's Hysteria over Fracking Sand and Chemicals and Why Sand Is The Latest Front On The War On Fracking (Yes, Sand) and in New Republics Scott Walker's Sand Grab: Wisconsin Wants a Piece of the Fracking Boom, No matter who Gets Hurt.

Hi-Crush Partners LP

As of New Year's day, HCLP last close was 37.98. HCLP provides a yield of 5.16% with a dividend coverage of 7.3. Thomson Reuters predicts a mean 12 month target price of $32.90. The tables below provide a snapshot of the company's fundamentals and earnings.

.5 16.4 14.4 134.53% 47.7%
46.88% 4.5 3.3 25.10 42.41 26.54

Undeniably impressive figures.

Here is a brief description of HCLP as provided in their most recent 10Q report.

We are a pure play, low-cost, domestic producer and supplier of premium monocrystalline sand, a specialized mineral that is used as a proppant to enhance the recovery rates of hydrocarbons from oil and natural gas wells. Our reserves consist of "Northern White" sand, a resource existing predominately in Wisconsin and limited portions of the upper Midwest region of the United States, which is highly valued as a preferred proppant because it exceeds all American Petroleum Institute ("API") specifications.

So far so good, but as I read further into the companies' 10Q report, I found reason to pause. Read the excerpt below.

A substantial amount of our revenue is generated from three customers. One of these customers is not investment grade. Our customers are generally pressure pumping service providers. This concentration of counterparties operating in a single industry may increase our overall exposure to credit risk in that the counterparties may be similarly affected by changes in economic, regulatory or other conditions. If a customer defaults or if any of our contracts expires in accordance with its terms, and we are unable to renew or replace these contracts, our gross profit and cash flows, and our ability to make cash distributions to our unitholders may be adversely affected.

In other words, HCLP relies on three customers for the bulk of their business.

Give me just a minute guys. I have to conduct a complex arithmetical analysis known only to those who have provided two or more contributions to Seeking Alpha.

(This little piggy went to market,

This little piggy stayed home,

This little piggy had roast beef,

This little pi…uh-oh!)

HCLP didn't pass the complex analysis known as the This Little Piggy customer base test. As a matter of fact, I couldn't even make it through the pair of piggies that dine on their fellow barnyard buddies. I have a ridiculously high standard in that I require most companies in my portfolio to serve more customers than a baby has toes on one foot.

I had to ask myself, "What can happen to HCLP stock if they lose a customer?"

Can HCLP lose customers or is fracking sand of such high worth that oil exploration outfits are knocking on their door and begging them for more product? Drill deeper into their 10Q and you can find some insight into that subject. An excerpt from the latest 10Q report follows:

In May 2012, Hi-Crush Operating LLC, a subsidiary of the Partnership, entered into a supply agreement for frac sand with Baker Hughes Oilfield Operations, Inc. ("Baker Hughes"). On September 19, 2012, Baker Hughes provided notice that it was terminating the contract and on November 12, 2012, Hi-Crush Operating LLC formally terminated the supply agreement and filed suit in the State District Court of Harris County, Texas. On October 8, 2013, Hi-Crush Operating LLC entered into a settlement agreement with Baker Hughes pursuant to which Hi-Crush Operating LLC and Baker Hughes agreed to jointly dismiss the lawsuit between the parties and, in connection with the settlement, the parties entered into a six-year supply agreement that requires Baker Hughes to purchase minimum volumes of frac sand each month.

Here are my concerns:

#1 There are several substitutes for fracking sand: Ceramic beads, sintered bauxite and small aluminum beads.

#2 Fracking sand operations are largely curtailed when temperatures dip below freezing. HCLP mining operations are conducted in Wisconsin.

#3. There are health concerns surrounding the production and use of fracking sands.

#4 Considering the high demand for fracking sand and the concerns listed above, can a competitor provide a product that adversely affects HCLP profits?

#5 HCLP relies on three customers for the bulk of their sales. In the past, one of those customers and HCLP had a major conflict which resulted in the termination of their contract.

I can understand how others would find HCLP a compelling stock. For those that purchase HCLP, I concede that it has the possibility of increasing greatly in value. I concluded, however, that HCLP would not appear on my buy list.

Disclosure: I 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.