Sunday, May 19, 2013

Carbo Ceramics ( NYSE - CRR ) -- Sees Better Days Ahead

Carbo Ceramics (CRR $70.00) appears on track to produce unexceptional Q2 results.  The same factors that drove down performance in the March quarter are continuing to exert an impact.  Drilling activity remains depressed, the result of natural gas prices that still are below production cost.  Oil drilling is constrained by infrastructure bottlenecks.  Direct competition from lower quality Chinese proppants continues to pressure prices.  Carbo has scaled back prices to preserve and expand its market share.  That's had the perverse effect of preventing the Chinese stockpiles from winding down.  Imports of fresh Chinese proppants have virtually stopped.  Most of that output now is being used in China itself.  But inventories built up in 2011 remain elevated.  Margins have been depressed further by Carbo's own distribution problems.  The company has been forced to expedite deliveries to North Dakota and other emerging territories.  Marketing expenses are up, too.  Carbo has been engaged in an extensive education campaign with prospective customers to demonstrate the superior rate of return its ceramic proppants deliver.  Those field trials typically involve deep discounts, plus extensive consulting services.

Volume should rebound in the September quarter.  Chinese inventories are expected to slide, opening up new customer opportunities while alleviating price pressure.  Distribution costs are coming down, moreover, now that depots, rail links, and other fixed assets have been deployed.  Field trials are likely to lead to full margin sales.  A second product line -- resin coated sand -- is gaining business from raw sand users, too.  Raw sand now represents 75%-80% of the entire proppant market but drilling companies are gravitating toward the resin coated variety, due to its greater strength.  New wells increasingly are deeper and create higher pressure on the proppants, which hold the rocks open during the fracking process so natural gas and liquids can escape to the surface.

A surge in natural gas drilling is possible if the federal government allows LNG exports.  Several facilities are under construction around the country.  Other existing energy plants could be modified to handle "liquefied natural gas" exports.  Natural gas sells for $4.00 per Mcf in the United States.  In Europe the tab is closer to $10.00; in Asia, $15.00 is common.  Even at those prices the Btu content is higher per Dollar than petroleum.  The Obama Administration has declined to approve natural gas exports to date for a variety of political reasons.  If the okay is given drilling activity is sure the increase.

A new proppant technology could widen Carbo's competitive advantage.  The first application will occur later this year in a deep offshore well, under extreme pressure.  Development is underway to apply the new technology to Carbo's standard product line, enhancing price performance.  A larger market share could result.  Those upgrades could hit the market in 2014.  Long term performance could be amplified by international demand.  Fracking is primarily a U.S. technology at present.  But China, Eastern Europe, and other regions are learning the ropes.

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