4.3% Dividend from Sand? Yep, with this Stock Pick, Thanks to the US Energy Boom

05/23/2014 5:00 pm EST

Focus: ENERGY

Jim Jubak

Founder and Editor, JubakPicks.com

Can an investment in sand sound like a good idea? It can if the sand is sold for use in the US natural gas and oil sector says MoneyShow's Jim Jubak who is buying shares of this seller of sand, as of today, May 23, 2014.

On May 21, I sold TECO Energy (TE) out of my Dividend Income Portfolio. Today, May 23, I’m adding Hi-Crush Partners (HCLP) to that portfolio. This master limited partnership yields 4.27%. My target price for the units, which sold at $49.25 at 3:00 PM New York time on May 23, is $52 a unit.

It looks like Hi-Crush sells sand. And, indeed, it does, to the glass industry, to the construction sector, and, most importantly for recent growth, to the natural gas industry for use in fracturing (fracking) shale to release gas and oil. Sector-wide shipments of sand for fracking jumped to 20.9 million tons in 2012 from 4.9 million tons in 2007, according to market researcher Freedonia Group. Freedonia projects that demand will double again to 52.1 million tons by 2022.

Certainly if you don’t have the sand mines—especially the sand mines in the Midwest that produce the hard, round sand that the oil and gas industry most prize—you’ve got nothing to sell.

But the real profits come these days from logistics—from getting the sand from mines, onto trains, and then transporting it and storing it near the shale operations that use it. A ton of sand that sells for $50 at the mine goes for $130 at the drilling area, US Silica Holdings (SLCA) CEO Bryan Shinn told Bloomberg. Adding mine capacity isn’t enough—it’s the investments in infrastructure that are driving revenue and earnings growth at companies such as Hi-Crush and its competitors.

Hi-Crush has sand reserves that Credit Suisse estimates at 30 years of supply. Its big mines at Wyeville and Augusta, Wisconsin, produce Northern White fracking sand at what Credit Suisse calculates is the lowest production cost in its industry.

From there, oil and gas customers can take delivery on sand that is then loaded on trains connected to the Union Pacific main line or operators in the Utica and Marcellus shale formations of Ohio, Pennsylvania, and New York can order from 12 Hi-Crush owned terminals in those states. Those terminals, Hi-Crush says, are spaced so that customers need to travel less than 75 miles from well site to sand supply. Hi-Crush acquired those terminals when it bought the biggest distributor in the Northeast last year.

It’s wise to take all projections about the growth production of oil and natural gas from shale with a grain of sand, these days. The profitability of the boom is running behind the industry’s need for capital and it’s still unclear what the long-term production profile is for wells in many of these geologies. Some regions that look like big plays now are likely to turn out to be much less attractive because complex geologies reduce production or raise costs.

I think those are indeed problems to keep in mind, say, three to five years out, but right now the oil and gas industry’s need to increase production from its wells—and lower costs if that’s possible—in order to make the interest payments on the debt operators sold to fund the development of leases points to rising demand for sand. Operators have discovered that in many geologies they can increase oil and gas production by using more sand to fracture the shale. That’s good news for growth at Hi-Crush.

The Wall Street consensus forecasts that EBITDA (earnings before interest, taxes, depreciation, and amortization) will growth from an actual $2.08 per partnership unit in 2013 to $2.84 in 2014 to $3.49 in 2015. If those estimates are accurate, EBITDA, as a multiple of distributions to unit holders, will go from 1.22 in 2013 to 1.62 in 2014. That should be enough, analysts estimate, to enable distributions to unit holders to grow from $1.95 in 2013 to $2.31 in 2014 to $2.71 in 2015.

Hi-Crush has climbed strongly with the rest of the sand producers in the last year on enthusiasm over the oil and gas from shale boom. But it isn’t unreasonably expensive. The price to earnings ratio is 22.69 on trailing 12-month earnings, but strong growth pushes that multiple down to 16.2 on projected 2014 earnings. The PEG ratio (PE to growth rate) for Hi-Crush is just 0.74 so you’re getting a lot of (projected) growth for your current dollars.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of Hi-Crush as of the end of March. In preparation for closing the fund at the end of May, as of the end of March I had moved the fund’s holdings almost totally to cash.

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