3 Reasons Frack Sand Investors Are Likely to Continue Suffering in 2016

Source: US Silica

Since bottoming at $26 per barrel in February oil rallied 54% to above $40. This has greatly benefited investors in America's four largest frack sand producers: Fairmount Santrol (NYSE: FMSA), US Silica Holdings (SLCA), Hi-Crush Partners (HCRS.Q), and Emerge Energy Services (NYSE: EMES), all of whose share prices have been chucked into a wood chipper over the past year.

FMSA data by YCharts

Find out three reasons why investors need to be prepared for the rest of the year to continue being a painful one. More importantly, find out which of these frack sand producers is best positioned to massively profit from the impossible to predict, yet inevitable oil recovery.

Earnings have plummeted and probably have yet to bottom

Sources: company earnings reports, 10-Ks, investor presentions

As you can see, while all frack sand producers suffered in 2015, the extent of the financial damage was far from equal. For example, Hi-Crush Partners managed to increase its market share the most last year, thanks in part to its extremely strong transportation network, which allowed it to deliver sand directly to oil producers rather than have its customers pick it up at its Wisconsin facilities (in basin delivery).

Meanwhile Emerge Energy was able to maintain the best overall pricing power because it put its large number of idle rail cars to use to nearly double the proportion of tonnage delivered in basin, from 23% to 42%.

Fairmount Santrol, on the other hand face the worst declines in price per ton, and thus the steepest drop in profitability, due to the fact that much of its business is in more expensive resin coated frack sand. With oil and gas producers desperate to cut costs as much as possible its more specialized sand simply couldn't maintain its premium price.

The thing that frack sand investors need to remember though is that 2016 is shaping up to be an even worse year for each of these stocks. That's because in the fourth quarter of 2015 the average price per ton sold fell to new lows indicating that 2016's average may end up even lower.

For example, Hi-Crush's Q4 average price per ton sold was $52 compared to its 2015 average of $62.

While Hi-Crush management doesn't think that prices have much further to fall that view may prove overly optimistic should rig counts continue declining from already record lows.

In addition, Fairmount, Hi-Crush, and Emerge face a bigger threat than simply continued margin deterioration that could potentially threaten their ability to survive the worst oil crash in over half a century.

Overly leveraged balance sheets
Each of the big four frack sand producers, save for US Silica, have potentially precarious balance sheets.

• Fairmount Santrol: 6.1
• Hi-Crush Partners: 4.3
• Emerge Energy Services: 8.6
• US Silica: 2.2

This means that US Silica is the best situated in terms of financial flexibility, to wait out the oil crash and potentially even profit from it. That's because US Silica recently announced that it's taking advantage of its far stronger share price to sell an additional 8.7 million to 10 million shares at $20 each. While this might result in as much as 16% shareholder dilution, it could also bring in as much as $200 million in gross proceeds which would raise US Silica's cash position to almost $500 million.

Not only would that further strengthen the company's balance sheet, but it would also greatly increase US Silica's financial flexibility as the industry waits for energy prices to recover.

For example, while US Silica could use that cash to pay down its debt, according to the secondary equity issuance announcement, the company is considering using its cash to acquire more distressed competitors.

That would raise US Silica's market share from an industry best 20% to 30% to 38% should it acquire Emerge Energy or Hi-Crush, respectfully.

While US Silica may not want to burden its own balance sheet with its peers large debt loads -- or deal with their creditors which have had to renegotiate their credit agreements with these sand producers -- none the less it's nice to know US Silica has the option to come out of this down turn stronger than ever.

Short-term sand demand is likely to keep declining

US Rig Count data by YCharts

Frack sand investors need to realize that the recent sharp recovery in crude prices was largely due to speculators hopes that an agreement to freeze oil production at current levels would alleviate the massive global surplus of oil and may not last.

After all, Iran says its committed to increasing production by over 1 million barrels per day and has called the freeze agreement "ridiculous". Meanwhile Russia continues to increase production and Saudi Arabia has said that without Iran and Russia's complying with the freeze it won't go along with the deal.

Bottom line
With oil once more declining and the global oil glut potentially set to worsen, investors need to realize that frack sand producers such as Fairmount Santrol, US Silica, Hi-Crush Partners, and Emerge Energy are in a precarious position.

Only US Silica has a strong and strengthening balance sheet while the others remain highly leveraged and at the potential of their creditors. Thus I continue to like US Silica the most as a long-term investment into the future of America's energy boom. However, remember that all frack sand producers are potentially high-risk investments and should only be owned as part of a well diversified portfolio.