The company put out a press release this morning noting that volumes lost from the Rosetta transition to sand were not able to be replaced and E&Ps continue to experiment with sand at the expense of ceramic volumes. We are lowering our 2014 and 2015 EPS estimates, driven by expectations for ceramic volumes to be in line with to lower than the first quarter, a bit less pricing than our previous model (driven by continued slack demand and too much supply for ceramics and resin coated), and no major changes to our cost structure in either year. We believe the demand issues probably put in question the timing of the second line at Millen (targeted to contribute to first quarter 2015 volumes).
On August 4, Rosetta Resources (ROSE $44.79) commented on its second-quarter earnings call that it would be changing its completion design for Eagle Ford wells and expected to save roughly $500,000 per well by switching from ceramic proppant to sand (presumably Northern Ottawa White sand). Rosetta is one of Carbo’s largest customers and we believe uses between 250 million pounds and 400 million pounds per year of ceramic proppant.
The worst case scenario for Carbo would be if all of Rosetta’s ceramic volumes came from Carbo and if Carbo was unable to replace any of the volumes with other customers. While we did not expect this scenario would be the most likely one when Rosetta announced its earnings call, today’s release from Carbo highlights the risk that Rosetta’s volumes may be difficult to replace in the next several quarters. We do not expect this will happen, but the exercise to understand the impact is useful because it provides an upper bound on what the market may perceive as the risk to forward estimates. This scenario would reduce annual revenues by $75 million to $120 million (250 million pounds to 400 million pounds at the second quarter’s average price of $0.30 per pound). Losing this level of volume and revenue would likely come at a decremental gross margin of at least 90% as the plants would still need to run at full tilt. Assuming decremental margins of 90% would result in a hit to annual operating profit of $68 million to $108 million (it would be tough to change operating expenses quickly, if at all, although sales expense [commissions] would clearly come down if Rosetta was not a customer). Assuming a $60 million to $100 million hit to operating profit (accounting for some sales commission savings) would reduce our 2015 operating profit estimate from $182 million to a range of roughly $80 million to $100 million. This in turn would reduce our 2015 EPS estimate from $5.04 to a range of $2.90 to $3.48.