(By Mani) Hi-Crush Partners, LP
) is an attractive platform for growth with a visible drop-down and continued development of additional frac sand capacity.
Hi-Crush is a pure play producer 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. Hi-Crush, a master-limited partnership (MLP) owns, operates, and develops sand reserves at its 561-acre Wyeville facility with integrated rail infrastructure, which allows deliver capacity of 1.6 million tons of frac sand per year.
Substantially all Hi-Crush's frac sand production is sold to leading investment grade-rated pressure pumping service providers under long-term, take-or-pay contracts. The frac sand from the Wyeville facility is contracted to four blue-chip oilfield service companies.
Frac sand is contracted with average terms of 4.7 years, which is sufficient length in the context of a cyclical rig market that is generally self-correcting within one to two years. At the sponsor level, it holds a second frac sand facility, which is expected to be dropped into the MLP within the next year and essentially double cash flow at the MLP.
"This provides solid visibility for near-term distribution growth. Longer term, we believe HCLP's first mover advantage into the frac sand arena under the MLP umbrella may allow for acquisition opportunities as smaller, private sand operators should find the MLP currency attractive," RBC Capital Markets analyst TJ Schultz wrote in a note to clients.
Hi-Crush's initial MLP asset – the Wyeville frac sand facility – mines high-quality Northern White sand, which is believed to be a preferred sand source for most E&Ps, given relatively high crush strength coupled with lower costs. Wyeville has 48 million tons of proven recoverable reserves, which equates to a 33-year reserve life.
The company has a significant plant design, construction, operating and logistical experience that is tough to replicate. The Hi-Crush Wyeville facility is one of the most efficient frac sand facilities operating today, which leads to lower operating costs and a unique, competitive advantage.
In addition, the Wyeville facility is located on unit train-capable rail, which significantly lowers logistical costs. Wyeville's operating costs of ~$20-25/ton are among the lowest in the industry.
"We believe Hi-Crush is viewed as a base load supplier for each of its customers, and as the OFS companies continue to reduce the number of frac suppliers they support, the relationship between Hi-Crush and its customers should only strengthen," Schultz said.
Meanwhile, Hi-Crush has a clean balance sheet and with no debt. This should allow for debt-weighted growth near term, providing for maximum accretion from drop downs and potential growth projects.
A solid balance sheet would allow it to maintain the distribution through a typical 12-18 month down cycle. It has an annualized minimum quarterly distribution of $1.90/unit (9.3 percent at current yield).
"We forecast an annualized distributions of $2.18 (+15% Y/Y) by the end of 2013 and $2.28 at the end of 2014 (+5% Y/Y with FY2014E +11.8%)," the analyst added.
Despite the protected cash flow stream, highly visible drop down growth and pristine balance sheet, Hi-Crush is trading at a discount to most MLP peers.
"We believe the discount is primarily due to two factors. First, we believe there is some uncertainty that HCLP would have to restructure its take-or-pay contracts if the rig market were to turn. Second, HCLP trades at a premium to its closest frac sand peer, US Silica (SLCA)," Schultz noted.
The MLP is fairly well protected from a re-contracting risk perspective and the current 9.3 percent yield provides sufficient compensation for taking this risk.
"We also believe the premium to SLCA should narrow over time as SLCA claws back from the first half 2012 oil-price downturn," Schultz added.