What’s the worst of the S&P 500? Materials.
Yardeni Research provides performance updates for all 10 sectors of the S&P. Along with telecom services and utilities, materials stocks have achieved one of the worst performances year-to-date through August 13 — up just 9.8% compared to 18.8% for the index itself.
Industries within that sector that are performing poorly include aluminum, mining and steel. But are they all doomed, or can some stocks stage a comeback? I’ve got one stock to buy and one to sell from the bunch.
Stock to Buy
What the heck is a “proppant?” As InvestorPlace contributor Aaron Levitt would tell you, it’s a fancy name for sand and man-made ceramic materials. When combined with a fracking fluid such as guar gum, a proppant is able to widen cracked shale fractures, allowing more oil and natural gas to flow out. It ain’t glamorous, but it’s absolutely essential to the success of Marcellus, Utica and other shale plays across the U.S.
Hi-Crush Partners LP (HCLP) is a pure-play, low-cost domestic producer of this essential ingredient. Formed in 2010 by experienced oil services industry personnel, HCLP went public August 15, 2012 — almost one year ago to the day. Since its IPO at $17, the stock is up 37.2% through August 1, HCLP provides investors with a very attractive annual distribution of $1.90; those distributions are expected to increase by at least 19 cents in fiscal 2014 for a yield of 9.3%.
When it comes to investing, boring is better. That’s good news for HCLP investors, because frac sand is definitely not cocktail party material.
In June, HCLP completed its $125 million acquisition of D&I Silica, LLC. D&I is a leading distributor of sand to the oil and gas industry in the U.S. with 11 terminals in Pennsylvania, New York and Ohio. Its extensive materials handling experience gives HCLP a leg up on the competition, not to mention a wider distribution network for its frac sand.
In addition to its wholly owned facility in Wyeville, Wisc., HCLP acquired a preferred interest in 2012 in another production facility in Augusta, Wisc., for $37.5 million and 3.75 million convertible Class B units representing limited partner interests in the partnership.
Together, the two facilities have annual capacity of 3.2 million tons. Under long-term contracts, the company makes about $64 per ton, and at 100% capacity, each facility is capable of generating slightly more than $100 million annually. In order to grow, Hi-Crush will have to acquire additional reserves, so you can expect it to add to its debt in the coming years. But that shouldn’t be much of a concern, as the company generates significant free cash flow.
But when considering an investment in Hi-Crush, the fly in the ointment is the future of fracking itself. Most jurisdictions within shale formations in the U.S. have serious concerns about whether the huge amounts of water necessary to produce oil and natural gas can be safely disposed of. I believe technology will find a way to deal with one of mankind’s most valuable resources. Nonetheless, an investment in HCLP must be made with an understanding that a ban on fracking virtually puts an end to its business overnight.
It’s a risk that might be worth taking, but one that shouldn’t be forgotten or ignored. If you’re an income investor, HCLP has to be on your “buy” list.