Hi Crush Partners--Erratic Policies--no clear vision

[RTaber1]

Folks,

I spoke to an officer of HCLP in Houston last week to learn about the business and its new super $3 per share annualized dividend. In 2017 they
spent $30 million to buyback their stock to get it to rise to reward shareholders. Like many stock buybacks (more than more people realize), it did not
work. In 2018, they abandoned their steady increase distribution policy to pay a $3 annual dividend now yielding a (scary to experienced investor)
24% yield. HCLP does NOT intend this as a long-term distribution policy, but a one-time gift to long-suffering shareholders, how many are insiders I failed to ask but I wonder. Who is getting this money?

The firm's capital spending projects appear to be secure like their acquisition of FB for the last mile delivery of the sand and an unnamed "Supermajor" customer is committed to making up-front contract payments (?) to help them fund a new mine in the Permian Basin.

Meanwhile, they have at least $450 million in debt financed at 9% with an eight year maturity. That is okay, but if I were a shareholder, I would rather pay off all debt before throwing money back to the sharks in the tank. So I won't be a shareholder until the company shows a clearer vision for
using their cash flow.

Really, one gets the feeling they just want to be "bought out" and put out of their misery. Kinda like dreaming to marry a beautiful 20 year
old Russian model who thinks your age spots are cute! (Hold onto your pocketbooks).

Randyl Taber, Registered Investment Advisor

[dave_n]

Randyl, thank you for sharing your concern. As a shareholder, I too would prefer they retain some of the funds to cover their growth; however, I am also quite frustrated with the unrelenting short positions on this company. From my view, the aggressive dividend plan puts every short on notice that carrying on open position is going to be even more costly. It was a wonderful move in my view.

Unfortunately, under the new policy, shorts will likely cover leading up to ex-dividend, let stock rise, and then reapply short. I've been using call options to profit in short-term. Might even be worth selling some call options around ex-dividend date before shorts come back in.

Anyway, my view is that management is being a bit erratic so as to make it more difficult for shorts to operate. Now let's just hope that management's moves to battle the shorts don't increase risk to a level where we were all better off buying the bonds.

[dan_s]

The reason the dividend (actually a "cash distribution" to "unit holders") was raised to $0.75/quarter is because if they stay at that level for four quarters they can take out the GP's and easily convert to a C-Corp. They will just need to make the election to be a C-Corp. at that time (next summer). Viper Energy Partners LP (VNOM) did this in May. It is the "easy way" to become a C-Corp.

Why convert to a C-Corp? Because a lot more funds can by C-Corp. stock. Lots of hedge funds cannot own MLPs. Laura Fulton and I discussed this prior to her presentation at our luncheon in Dallas on June 12th.

Hi-Crush is the low cost producer of Northern White frac sand, which is the #1 proppant.
Hi-Crush has the best distribution network
Hi-Crush has a working sand mine in West Texas and they are doubling its production
Hi-Crush has the best well site sand management system and that division is growing rapidly

Global demand for oil cannot be met without U.S. shale oil and the only way that shale oil production continues to grow is with more and more frac sand each year. Demand for frac sand is much higher today than it was when oil was over $100/bbl.

Hi-Crush has more than enough DCF to cover the $3.00/year dividend.

I have a VERY HIGH level of confidence in my forecast model for this company, primarily because it is very simple. Just take five minutes to look at the forecast model that you can download from the EPG website.

[ddlopata084]

Worthy of a read is the CVIA conference call and their description of the pricing situation that has occurred in Q3, at least for their sand business. HCLP, if you read their CC, was not as concerned about pricing in coming Qs and disagree with the analysts view of their revenue and earnings in the coming quarters (read their latest presentation and study the Free Cash flow slide). The perception of sand over supply, build-out of in-basin mines - these are what is affecting the trading on this ticker. The last 2x days, almost 20% of the daily volume in HCLP is short volume. I believe Dan Loeb was one of the first to present a short thesis for frac sand publicly. Either you're in that camp or you're not. I personally don't like the c-corp idea, and I don't think it will mean a hill of beans to the stock price if there is over-supply and loss of reasonable per ton contribution margin in the industry. I'd rather them stay MLP... I haven't sold a share and have a favorable view on management and how they've run the business over the last couple years. But everyone has a right to their opinion.

[dan_s]

My take on the C-Corp. (discussed with Laura) is that they have talked to a lot of funds who like the business, but cannot own MLPs. If they do convert, it will happen next summer. If they can hold the dividend at even half the current rate, the share price will go up.
I think Hi-Crush's "last mile delivery systems" does separate them from the pack. They have the best overall distribution system and a solid reputation of delivering high quality sand on time.

My take on frac sand demand is that it must continue to go up unless there is a global recession. This world runs on oil and the only way growing demand for oil can be met is through development of the U.S. shales. We will need more and more horizontal wells each year just to hold production flat and they are using more and more sand per completion.

[dave_n]

Dan,

Thanks for the update. I had a sense they were trying to expand their attractiveness to the investment community. The management team is fantastic and very pro shareholder.

Generally, it's my hypothesis that the investment community observes growth in Permian slowing while more sand production coming online. To state the obvious, increased supply with reduced demand pushes down gross margins per ton. So we seem to be caught in this quarter-to-quarter view where the market sees margin isn't impacted, stock recovers, and then the shorts come back with story of margin pressure. It would go a long way if the company could speak to forward commitments as it relates to margin, if they have it. They say they have 75% committed, but is price locked or variable?

Although I'm long the stock, always looking for ways to profit. Given volatility with what I perceive to be low downside risk at $11 price point, I'm buying calls now. Plan to sell calls on half my shares going into ex-dividend this time (didn't see it as an opportunity last quarter). You've given us a great one to move around here. It's up to us to translate the information into a meaningful trading strategy that works for our risk tolerance.

Thanks again Dan, great company and management. I'm patient and convicted for the long-term with this one. Plus lots of trading opportunities with volatility!

Dave

[dan_s]

There is talk of several companies pushing back well completions in the Permian Basin until pipeline takeaway and regional prices increase. However, there is also talk of well completions in other areas (Eagle Ford, SCOOP/STACK, Bakken) increasing to get production and proven reserves up heading into year-end. Regardless, it is just a short-term timing issue. Eventually, DUC wells do get completed.

An increase in the DUC wells in the Permian for a few quarters is no big deal IMO. All it does in make frac sand demand in the Permian Basin higher in 2H2019 and BTW Hi-Crush is doubling their capacity at Kermit.

Hi-Crush is also #1 in the Marcellus/Utica and there is going to be a lot of activity up there if I am even close to right about the gas market.

Demand for U.S. oil, gas and NGLs continues to go up. Lots and lots of horizontal wells must be completed to meet this demand growth.

HCLP is a "high beta" stock, but the company is rock solid and so is the $0.75/qtr dividend.

[drlink]

Credit Suisse this morning questions HCLP's "contract sanctity." Because HCLP is making significantly higher margin on Kermit than peers ($35ton vs $20-25 ton) With $20 ton they see implied 2019 Ebitda dropping to $105 M from $186M, with implied downside of 58%.

[ddlopata084]

Credit Suisse:

HCLP's Fate Tied to Permian Contract Sanctity. HCLP's downside risk profile looks relatively similar to that of SLCA until our most bearish scenario, in which we assume Permian contract sanctity is thrown out the window. This is because HCLP is making a significantly higher margin on its Kermit volumes vs peers ($35/ton vs $20-25/ton). For example, in a scenario with $20/ton minegate NWS and Permian sanctity, we see 16% downside risk to HCLP. However, marking its Kermit volumes to market for 2019 drops implied Ebitda to $105M from $186M, with implied downside of 58%. This compares with our published $260M and consensus of $322M.

[ddlopata084]

HCLP just released a new slide set today. They dropped view on tons in Q3 by about 7%. I assume this is due to losing non-contracted volumes to competitors dumping tons into the market. Below are their comments from one of the slides:

Secular trends in frac sand demand continue to improve; long term trends are positive
• E&Ps’ slowdown in activity and spending due to unique combination of transitory factors:
• Early achievement of production targets and early exhaustion of 2018 budgets
• Permian takeaway capacity concerns
• Impacts materialized in August and are expected to last through the remainder of 2018
• Start-up of additional in-basin Permian capacity creating temporary oversupply of Northern White fine mesh sand as customers adapt to market dynamics
• Permian in-basin market has not been impacted to the same extent; Kermit facility continues to run at full capacity
• Expect resumption of E&P capex spending and demand growth in first quarter 2019

[dave_n]

Very pleased that management didn't wait until 10-Q. Better to know early. Confirms management is transparent.