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Old West Investment (Stock Idea): Carbo Ceramics (CRR)

  • Technology company that provides products and services to the global oil and gas and industrial markets. Their primary product was historically ceramic proppant for the fracture stimulation of oil and gas wells where downhole conditions were too extreme for traditional sand proppant
  • Ceramic proppant volumes fell precipitously with the decline in oil prices as industry activity was curtailed and customers could no longer afford to use premium proppants. Company responded initially by expanding their traditional sand volumes to leverage their logistics capacity and more recently has begun servicing customers outside of the oil and gas industry with products such as ceramic grinding and casting material and material for mineral processing
  • Regular sand proppant cannot withstand the high pressures of certain wells, such as many of those drilled in deep water or onshore at great depths. Other performance characteristics such as uniformity of grain and sphericity can also prove superior if commodity prices support the increased cost to operators. For industrial markets, the ceramic products reduce the amount of material needed, lower component wear and maintenance costs, reduce defects, and eliminate respirable silica dust to comply with OSHA exposure limits
  • New end markets they have pursued have certainly started to bear fruit. Whereas base ceramic accounted for over 80% of their revenue in 2014, the growth in other product lines has reduced their reliance on the segment to 30%, with 70% of their revenue now coming from other areas. That said, continued strength in commodity prices has boosted activity levels across the industry, and their proppant volumes have increased for 7 consecutive quarters after bottoming in 2Q16
  • While they do have some debt ($88 million as of 4Q17), it’s almost entirely offset by their cash balance. With cash from operations recently turning positive, the company has a long runway ahead of them to let this transformation play out
  • Chairman is one of the largest shareholders with over 12% of the shares. The CEO is a top 20 shareholder and has been buying shares. The CFO and several VPs have all bought shares in the last year
  • Company trades for less than half of book value, near its all-time lows, despite the fact that operations have been steadily improving. Because much of the improvement has come from restarting or repurposing idled capacity, capex requirements are minimal and the increase in cash generation is converting almost entirely to FCF. Given the distressed valuation, you don’t have to look far out to see a double-digit FCF yield on a company with rapidly improving fundamentals. We don’t think that should be the case and expect the stock to rerate much higher when the market realizes that
  • With cash flow turning positive in the most recent quarter, we think net income will follow in the next few quarters and at that point, analysts and market participants will start to revisit the name. Whereas much of the discussion a year or two ago was on whether the company would survive, once they show that their revenue growth is leading to sustained profitability the analysis should change to one of trying to value that accordingly
  • Less than four years ago it was trading for $150 per share and was worth over $3bn. We think in the near term, given the operational improvements and capacity for free cash generation, it’s not much of stretch to see it trading in the mid- to high-teens, which is our base case valuation
  • We believe the downside risk is muted here, given the company still trades as though it is going out of business. The bear case is well known, which is that oil prices revisit their lows, activity levels, and proppant volumes plummet, and the company’s diversification efforts are unsuccessful
  • Because they are reliant on the oil and gas and industrial sectors, any prolonged economic downturn would have a substantial effect on their end markets. We think the current valuation provides a margin of safety that would partially insulate them from this, but it would undoubtedly temper our enthusiasm for their growth potential

Hidden Value Stocks 1Q18

Image Source: Carbo Ceramics

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