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Morningstar | Hi-Crush Reports Weak 4Q Owing to Downturn in Frac Sand Demand

Hi-Crush Partners reported weak fourth-quarter results, chiefly owing to the downturn in frac sand demand. Revenue was down 24% sequentially on a 29% decrease in volumes sold as well as weaker pricing, offset by higher logistics-related revenue. Total margin per ton (including logistics services) fell to $14 from $24 in the prior quarter, reflecting chiefly weaker pricing as well as negative operating leverage effects from reduced volumes. Our fair value estimate and no-moat rating are unchanged for now.

The bottleneck in Permian Basin takeaway capacity has caused a slowdown in U.S. shale completion activity and therefore reduced the demand for frac sand. This completion slowdown accelerated in the fourth quarter, and we think industry frac sand demand declined about 20% sequentially. However, the takeaway constraints are still set to be alleviated by the second half of 2019, meaning that these issues are largely temporary. On the other hand, the ongoing expansion of low-cost in-basin sand capacity is a permanent headwind affecting frac sand producers' pricing and utilization. In-basin sand capacity expanded throughout 2018, and we forecast that it will continue to grow in coming years.

Investors appear to have reacted quite negatively to Hi-Crush's disclosure in January that it renegotiated some of its Kermit, Texas, mine sand contracts as a result of customer demand for lower pricing on these contracts. We had never expected the generously wide margins prevailing in current contracts to be sustainable. Our forecast is that gross margin per ton on these contracts falls from about $35 in 2018 to $15 over the next two to three years.