CARBO Ceramics Inc. (CRR, Financial) is the world's largest supplier of ceramic proppant for fracturing oil and gas wells and a major supplier of resin-coated sand proppant, a provider of the industry’s most widely used fracture simulation software, and a provider of fracture design and consulting services. It also provides a broad range of technologies for spill prevention, containment and countermeasures, along with geotechnical monitoring. In October 2009, Falcon Technologies and Services Inc., a wholly-owned subsidiary of CRR, purchased substantially all of the assets of BBL Falcon Industries Ltd., a supplier of spill prevention, containment and countermeasure systems for the oil and gas industry. The acquisition broadened the company’s product and service offerings to its existing client base. Falcon Technologies uses proprietary technology to provide products that are designed to enable its clients to extend the life of their storage assets, reduce the potential for hydrocarbon spills and provide containment of stored materials.
Valuation
CRR is currently trading at a P/B of 2.47x, a 29% discount to its five year average P/B of 3.50x. Its previous historical valuation low was 1.54x P/B in 2009 during the global financial crisis. In terms of earnings based valuation multiples, CRR trades at 14.3x trailing twelve months P/E and 7.5x trailing twelve months EV/EBITDA. CRR has delivered a five year average ROE of 16.1% and five year book value per share CAGR of 14.1%.
Financial And Business Risks
CRR is debt free with cash and cash equivalents of $52 million representing 3% of its market capitalization of $1.7 billion. However, this does not take into account off balance sheet liabilities such as operating leases and purchasing obligations amounting to $237 million. Operating lease obligations relate primarily to railroad equipment leases and include leases of other property, plant and equipment, while purchasing obligations that refer to natural gas contracts and any raw materials contracts for kaolin and bauxite.
CRR's operations are dependent upon the number of natural gas and oil wells completed in geologic formations where ceramic proppants are used in fracture treatments, and these activity levels are in turn affected by both short-term and long-term trends in natural gas and oil prices. In 2011, natural gas prices fell significantly, and some companies reduced drilling activity for natural gas.
The expiration of key patents owned by CRR in 2006 and 2009 has resulted in additional competition in the market for ceramic proppant. The proppant market is highly competitive and no single supplier is dominant. In the second half of 2012, oversupply of proppant in the market is creating sales volume volatility for CRR, as customers work through inventories of Chinese ceramic proppant. As a result, CRR is currently experiencing price pressure on its products. However, CRR is confident that once supply/demand conditions rebalance, CRR's sales will be driven by long term demand for its high quality, high conductivity ceramic proppant.
CRR's capital intensive business draws significantly on capital expenditure and working capital requirements. For the past three years, inventory days have spiked up to more than 100 days. In contrast, from 2002 to 2008, inventory days have stayed within a range of between 60 and 80 days. Capital expenditures as a percentage of free cash flow have ranged from 13% to 20% from 2009 to 2011.
Business Quality and Capital Allocation
CRR's ceramic proppant presents a strong value proposition for an E&P operator; an E&P operator should see a 20% increase production rates and estimated ultimate recovery with CRR's ceramic proppant, compared with a sand based proppant. CRR's ceramic proppant also has higher conductivity than other low quality ceramic proppants, which gives CRR a competitive advantage as conductivity is the critical factor in well production and ROI.
CRR has paid out dividends in every single year since 1996 and has a dividend yield of 1.46% with a corresponding dividend payout ratio of 19.2%. Dividends per shares have increased every single year for the past 12 years, representing a dividend per share CAGR of 16%. Dividends are paid out quarterly.
Conclusion
Valuations are not compelling. The key to CRR's fortunes is customers' decision on cost versus benefits in choosing between cheaper proppant or CRR's quality proppant.
Disclosure
The author does not have a position in any of the stocks mentioned.
