Thursday, January 31, 2013

Carbo Ceramics ( NYSE - CRR ) -- Pulls Away

Carbo Ceramics (CRR $80.00) reported excellent Q4 results.  Sales were slightly below our estimate at $153.6 million.  U.S. drilling activity experienced a larger than normal slowdown in December.  Earnings were $.25 a share above target, though, at $.93 a share.  (That excludes a $.03 a share one time expense associated with a discontinued operation.)  Prices stopped going down in the period as the company's educational efforts started bearing fruit.  Carbo conducted an extensive marketing campaign throughout 2012 to demonstrate its technology's superiority.  The company is the leading producer of high strength ceramic "proppants" -- tiny spheres that drilling companies shoot into horizontal wells to keep the rocks open during fracking operations, to maximize the flow rate of crude oil or natural gas.  The deeper the well, the greater the pressure on the proppant.  Chemical giant St. Gobain offers direct competition.  A variety of Chinese manufacturers sell less functional ceramic proppants.  Some drillers use resin coated sand as a lower cost alternative in shallow wells.  Carbo has a line of sand based offerings, although it contributes just a modest percentage of revenues.  Larger drilling companies have developed their own sand proppants.  The risk of using less sturdy proppants is that they can collapse under the pressure, shutting down the field.

A new technology holds great potential.  Carbo has developed an even stronger ceramic technology that currently is being rolled out for particularly deep applications.  Initial customers will be offshore drillers with wells 20,000-30,000 feet deep, plus the water weight.  At this point wells that far down have been exploited with straight up and down well bores.  Carbo's technology will open up the horizontal potential, enabling each well to retrieve more oil and gas.  The basic technology, which remains a secret, is expected to be applied to most of Carbo's ceramic products.  That could raise price performance materially, boosting profitability and market share.  The technology probably will be implemented in Carbo's general product line in 2014.

Financial performance is likely to improve gradually in 2013.  Carbo indicated it doesn't intend to increase prices until volume achieves sustained momentum.  Results should benefit from rising revenues, nonetheless.  Margin expansion could develop later in the year, particularly if the natural gas segment bounces back.  New natural gas wells have taken a back seat to oil, mainly due to the price discrepancy.  A commitment to LNG exports could stimulate development again.  Greater natural gas use by utilities and industry promise further gains.

Our 2013 earnings estimate is unchanged at $5.45 a share (excluding stock option expense).  The long term outlook is bright.  Almost all new drilling at least considers some degree of fracking.  Carbo's new technology could preserve its lead in the U.S. market.  International markets could become more prominent in future years.

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