Carbo Ceramics ( NYSE - CRR ) - Short Term Outlook Turns Cloudy

Carbo Ceramics (CRR $100) reported excellent on target Q4 results.  Our estimates had been below the Wall Street consensus, though, so the stock price declined substantially after the news was made public.  Sales advanced 32% to $158.1 million.  Earnings (excluding non cash stock option expense) rose 61% to $1.45 a share. For the entire year sales climbed 32% to $625.7 million.  Our estimate was $625 million.  Earnings finished at $5.75 a share (+64%), right on the mark. 

Q4 results were impacted by a sharp reduction in natural gas drilling caused by the warm winter.  That oversupply was exacerbated by a rapid build-up in production earlier in the year.  A lift in oil fracking offset part of the natural gas decline in the quarter.  Natural gas demand for Carbo's products is continuing fall, though.  And the company probably won't be able to keep ramping up oil market deliveries in the near term due to intrastructure problems.

That infrastructure build-out in the Dakotas is likely to start bearing fruit by mid-year.  Carbo is almost certain to benefit from the transition from natural gas to oil, once the company gets set up, because its superior technology works better on oil and the price of oil is apt to be less volatile since it's set by worldwide demand.  Natural gas prices tend to be affected by local supply and demand factors.  The company is building depots out west, and it's cultivating new and existing customers.  The technology already is well established.  Prospective customers are continuing to identify new drilling targets with computers.  And overall drilling costs are coming down with experience.

Chinese competition remains a threat of vague proportions.  Carbo is well positioned to deflect most attempts by the Chinese to break into the market.  Carbo is a domestic company and it understands how the oil patch thinks and operates, so it should stay ahead of the pack from a marketing standpoint.  Substantially lower costs naturally will attract attention, though.  And some shift to Chinese suppliers is bound to happen, especially in the natural gas segment where proppant quality isn't always a critical factor.  Chances are Carbo will become more of an oil play over time.  The company is aggressively developing lower cost proppant product lines, though.  It could remain a major factor in the natural gas area, as well.

Shale drilling remains in an early stage of development.  We've reduced our 2012 estimates to reflect the levelling off in oil drilling that's likely to occur in the first half of 2012.  Those logistical issues should be resolved by mid-year, opening the way for a resumption of above average growth extending well into the decade. Carbo also is developing several high potential software and spill containment product lines which could provide further leverage. 

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Carbo Ceramics ( NYSE - CRR ) -- Shrugs Off Competitive Threat

Carbo Ceramics (CRR $140) reported excellent on target Q3 results.  Sales advanced 41% to $167.1 million.  Earnings climbed 81% to $1.61 a share (excluding stock option expense).  Carbo is one of the two leading manufacturers of ceramic proppant used by oil and gas producers in shale production.  The tiny spheres are inserted into the rock after it's been fractured to let the oil or gas flow to the surface.  Most wells are drilled horizontally and typically are 10x longer than straight up and down wells.  So more material is required.  The proppant is injected into the well with a mixture of water and a jello like material.  The water drives it in.  The jello keeps it in place until everything settles.  Then it disolves.  Since the proppants are round plenty of area remains for the oil or gas to flow back up the well bore. 

Most wells are 8,000 feet or more below the surface, far below the water table.  Occasionally natural gas escapes towards the surface during the fracturing process.  When that happens it can mix into the water supply.  Technically speaking the jello material is made from chemicals, though it isn't much different than actual Jell-O.  That gets loose once in a while, too.  The Environmental Protection Agency has moved aggressively against those contamination issues, blocking natural gas development in large sections of the country.  The EPA additionally has blocked Carbo from building new production facilities in some areas.  For all the hoopla the amount of actual damage is negligible in relation to the volume of energy produced.  So while expensive remediation efforts might be required the industry appears likely to keep growing at a brisk pace well into the future.

Growth is accelerating in the oil shale segment.  Carbo got its start in shale gas.  Its ceramic proppants worked better than conventional sand at keeping those new age wells open.  Sand continues to be used in straightfoward applications because it's less expensive.  But operators increasingly are switching to manufactured proppants to maximize the flow rate.  In the shale oil segment, that conductivity advantage is even more pronounced.  Drilling activity is surging because the market price of petroleum is 5x greater than natural gas on a Btu equivalent basis.  The potential profit is much greater.  In 2011 an estimated 32,500 oil wells will be drilled in the U.S., up 75% from the year before.  The entire increase is coming from the shale oil segment.  Natural gas wells are seen coming in at 19,500, up 5%.  At this point Carbo is sold out and can't keep up with demand.  New capacity is being brought on line, the EPA notwithstanding.  But the tight supply situation has caused drillers to seek alternative sources.  The resulting advent of new competitors has created some question marks about Carbo's long term outlook.

Saint Gobain, the other leading producer of ceramic proppant, is expanding capacity.  More ominous is a build-up in Chinese production.  The Chinese have entered the market with lower quality products but they've offered lower prices, as well.  The surge in industry demand has allowed Carbo to maintain margins and keep expanding to date.  And that trend could continue if the international market begins to adopt shale drilling.  For now the technology remains a North American specialty.  At some point the number of drilling rigs could max out, or energy prices might skid and cause some rigs to go out of service.  If proppant capacity keeps jumping an oversupply situation could develop.

Today, performance remains vibrant.  We have lifted our 2011 earnings estimate by $.15 a share to $5.65 a share.  A stronger showing is possible if the customary Q4 industry slowdown fails to develop.  Next year $6.60 a share (+17%) is a realistic target, in light of the economy and the Administration's efforts to promote green energy at the expense of fossil fuels.  New manufacturing capacity is in the pipeline.  If prices and margins aren't disrupted earnings could keep advancing at a 20%-30% rate well into the decade.

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Carbo Ceramics (NYSE — CRR) -- Bridging the Gap

There is a sizeable gap between current energy and the renewable sources that aim to one day replace them. Wind and solar power don’t produce harmful byproducts, but the cost is much higher than fossil fuels, even with government incentives in some countries. Natural gas is a cheaper, cleaner alternative to oil and coal, respectively. Huge deposits found in shale rock around the world have led many to believe that natural gas can bridge the energy gap.

Carbo Ceramics (NYSE: CRR $130.00) is the leading provider of ceramic proppants used in hydraulic fracturing (“fracking”), the technique used in shale rock gas and oil drilling. Wells are typically drilled 8,000 feet down, and then another 6,000 feet horizontally. Charges are used to break apart the rock. Then water, chemicals and proppant are pumped in under high pressure to further break apart the rock and release the gas or oil. As the water is pumped out, the proppant remains to keep the shale open and allow the raw fuel to escape back up the pipe.

The company offers three primary types of proppant: sand, ceramic and resin-coated versions the two. Sand is the cheapest and most commonly used; ceramic is more expensive up front, but used in the right situation it yields more gas and thus more cash flow. The resin-coated proppant is used in scenarios that risk proppants flowing back up the well and interfering with machinery.