Value Microcaps Junior Energy

[Bobwins]

Frack sand suppliers

I have been reading a lot about frack sand recently. The consensus seems to be that the best of breed horizontal shale wells require 2 to 3 times the sand and the wells are being drilled further in the horizontal sections. In addition, contrary to previous wisdom, finer mesh sand is being used. Coarse sand in the 20 size range was optimal previously but now fine mesh sand in the 40-70 size range appears to hold the cracks open longer and penetrate further into the frack openings.

So what does this mean?

It should result in much higher prices for frack sand of the fine mesh variety. Sand got down to below $20/ton in 2014-5. It's currently in the $30/tonne range and estimates are that it could reach $60/ton in 2017-18.

This should boost the main suppliers into profitability. Since 2016 was the turnaround year for both the completion technique changes AND increased drilling in the Permian Basin, 2016 was not profitable for almost all sand producers.

The lone profitable public sand company in 2016 was my current choice, SND or Smart Sand Inc. They earned $10.4 million or .42 eps vs $5million or .19eps in 2015. They also increased tonnage shipped to 826,400 tons from 750,700 in 2015. Almost all their profits were made in Q4, when they made .40eps.

So is Q4 repeatable? Unfortunately not. Q4 was unusual in that SND had about 80% of their supply contracts with a take or pay requirement. Q4 was the settlement period for 2016 and one big client had to pay ~$18 million in fees for sand not taken. This boosted Q4 to a nice profit.

SND has since switched all their contracts to a monthly commitment fee for take or pay contracts. All their clients pay a monthly fee. Then when they order sand, the deliveries are subtracted against the already paid fee. In this way, there is no massive settlement due by their customers, which causes bad feelings and can cause financial stress.
Smart Sands goal is to have 80% of their contracts as take or pay and then sell 20% to the spot market. This formula doesn't give them the biggest boost during bull markets for frack sand prices BUT does give them sustainability thru low pricing periods. Look at all their competitors, HLCP, FMSA, SLCA, EMES. They all lost money in 2016 and yet the stocks soared, in anticipation of improving results.

SND did not participate in all that enthusiasm because it only came public in Nov 2016. IPO was priced at $11 and is down big today at $14.77.

Here's what I like about SND. Conservative, sustainable approach with their take or pay contracts. They are in the sand business for the long haul. They have excellent reserves, with about 400 million tons of reserves. Importantly, they have 80% fine mesh sand. This was not so good in 2014, when everybody only wanted coarse sand but great today. At their current capacity of 3.3 million tons/yr, their reserves will last over 100 years. They are spending 50+million this year to increase capacity to 4.4million tons.

Many of their competitors developed sand reserves with a high percentage of coarse sand. This is a major deterrent to future profitability and supplying customers with what they want. SND didn't seek business during the extreme downturn. They minimized shipments rather than sell at breakeven or a loss. Some of their competitors sold at a loss, as evidenced by their financials. SND is also a low cost provider. They have excellent rail logistics on their main plant and have two major railroads with spurs to their property. This provides competition and gives them low cost for rail shipments, which is a major cost in sand.

SND is selling at a high p/e in the 50's, however they do have a p/e while their competitors only have losses. They have low costs so when they ramp up volumes, they will be very profitable. They have the preferred fine mesh sand. They only sold 826,000 tons in 2016 vs their 3.3 million capacity so I asked them why they were spending $50million to expand to 4.4. They said they have started 2016 at a 2 million ton/yr pace and growing. So at the normal contract size of 300,000 tons, it won't take many for them to reach their capacity. Also they want to stick to their 80/20 porportion of take or pay vs spot. 80% of 3.3million = 2.64 million tons/yr so they are already a couple contracts away from 100% of their take or pay desired level. They want that 20% spot sales so they can participate in the rising sand prices but still have the stability of take or pay.

Here is their latest presentation:

http://ir.smartsand.com/phoenix.zhtml?c=253836&p=irol-presentations

Not sure why the stock has been selling off. I think they are in the right place at the right time. I think Q1 financials will show them to be profitable and selling a lot more sand. They also think their competitors will have problems delivering into the demand for fine mesh sand.

I bought SND over the past couple weeks and have an average cost of 15.77. About a buck underwater but I still think SND is a good company in a hot sector. I think Permian drilling will increase along with a revival of pockets in the Eagle Ford and Bakken. US producers will continue to grow production profitably because their new completion techniques are lowering their costs to well below $50.

I also hold canadian startup SNS.v, Select Sands. Select Sands has a plant in Arkansas and has a logistical advantage of being 650 miles closer by rail to the Permian than the Wisconsin mine of SND. This should lower their costs by $5-10/ton vs competitors. It is a startup but they have contracts and have started shipping sand. Q1 will show their first revs. I like the story but SNS.v has reserves of about 40million tons and capacity of 600K tons/yr. So much smaller than SND. They do have plans to double capacity this year and are a MUCH lower market cap to any of the US players. SNS.v is up 10% today to C$1.70. My avg cost is C$1.55.

http://www.selectsandscorp.com/wp-content/uploads/2017/04/SNS-Powerpoint-Apr2017.pdf

Frack sand stocks were hot in 2016. I think the trend will continue in 2017. The projections are that there won't be enough fine mesh sand by late 2017 as the whole industry transitions to increased fine mesh sand and longer horizontals. I was encouraged that SND already counts EOG as a customer. They are the premier E&P in the shale space with leading edge completion techniques.

Not sure if it's just a coincidence but both SND and SNS.v recently got significant contracts from oil services firm, Liberty Oilfield Services, LLC. They contracted for up to 1 million tons/yr from SNS.v, which is more than their current capacity of 600,000 tons. So SNS.v is obviously expanding.