The daily headlines are brutal for oil and oil services investors. With eight-year lows in the price of crude, and more rigs idle now than in years, it seems never ending. The negativity for the sector is as high as it has been since the beginning of the Great Recession. A new report from Merrill Lynch, instead of focusing on the big cap diversifieds, dives into a group of master limited partnerships (MLPs) that may produce solid oil beta.
The Merrill Lynch team initiated coverage on the frac sand companies and MLPs, which are the firms that provide the sand to the drillers doing the fracking. While the analysts forecast a frac sand demand decline of approximately 10% to 15%, they also see that metric partially offset by a 25% forecast increase in proppant (frac sand) per well in 2015. With an expected first half of 2015 trough in the oil and oil service stock debacle, these stocks may make good sense for clients now.
The three stocks initiated at Merrill Lynch rated Buy are: Emerge Energy Services L.P. (NYSE: EMES), Hi-Crush Partners L.P. (NYSE: HCLP) and U.S. Silica Holdings Inc. (NYSE: SLCA). Note that their distributions may contain return of capital.
Emerge Energy Services
The company is a growth-oriented limited partnership engaged in the business of mining, producing and distributing silica sand, a key input for the hydraulic fracturing of oil and natural gas wells. Emerge Energy also processes transmix, distributes refined motor fuels, operates bulk motor fuel storage terminals and provides complementary fuel services. The company operates its sand segment through its subsidiary Superior Silica Sands and its fuel segment through its subsidiaries Direct Fuels and Allied Energy.
Emerge Energy shareholders are paid a monster 13.2% distribution. The Merrill Lynch price objective for the company is whopping $67. The Thomson/First Call consensus price target is even higher at $69.50. Emerge Energy closed trading on Tuesday at $42.61.
This is another one of the top frac sand producers to buy at Merrill Lynch. The company is an integrated producer, transporter, marketer and distributor of high-quality 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 reserves, which are located in Wisconsin, consist of “Northern White” sand, a resource that exists predominantly in Wisconsin and limited portions of the upper Midwest region of the United States. Hi-Crush owns and operates the largest distribution network in the Marcellus and Utica shales, and has distribution capabilities throughout North America.
Hi-Crush shareholders are paid a 7.95% distribution. The Merrill Lynch price target is started at $45, and the consensus is again higher at $47.67. Hi-Crush shares closed at $33.49.
This company does not have the uber-high yield of the other two, and it is also not an MLP, but it is also considered one of the premier companies in the industry. U.S. Silica is a leading producer of commercial silica used in the oil and gas industry and in a wide range of industrial applications. Over its 115-year history, U.S. Silica has developed core competencies in mining, processing, logistics and materials science that enable it to produce and cost effectively deliver over 260 products to the firm’s customers across all end markets.
The company posted solid earnings, but left Wall Street analysts with an outlook that, while not horribly negative considering the state of the current industry, did concede that this year will be challenging.
U.S. Silica shareholders are paid a 1.8% dividend. The Merrill Lynch price target is $37, and the consensus target is $38.46. Shares close Tuesday at $28.57.
Needless to say, this is somewhat of a contrarian play from Merrill Lynch. Given that these companies are the three main players in the frac sand business, any improvement at all in the overall industry should help to jump-start the shares or units higher. All three of the consensus price targets are higher than even the ambitious Merrill Lynch targets, so they are clearly not alone on this thesis. Investors should note, due to the industry slowdown, distributions could be cut.