The Hottest Shale Play in America Welcomes a New Winner

This established name just made an early move in the hottest shale basin in North America.

Jul 21, 2014 at 12:08PM

Frac Sand Mine Carol Mitchell

Frac sand conveyor belt in Wisconsin. Credit to Carol Mitchell

Proppant is the lynchpin of the shale revolution, and resin-coated sand has so far proven itself to be the most economical form of proppant for horizontal drilling. Because the proppant is necessary to keep a hydraulic rock fracture open, without such proppant, shale drilling would be impossible. 

One might think that sand would be a readily available commodity, but the challenge is in getting the large volumes needed for commercial-scale fracking operations, and doing so in an environmentally sound way. Adding to that complication is the specific need for higher-quality, white sand which is often found in only a handful of locations.

Companies such as US Silica (NYSE:SLCA), which have provided glass-making and manufacturing industries with the same resin-coated sand, have suddenly found themselves in a very lucrative, fast growing business. While there are new frac sand providers entering the business, US Silica has the advantage of already having huge plant capacity and a manufacturing logistics network that often, but not always, overlaps with America's shale plays. 

Permian Oil Growth

Source: EIA

Adding a piece to the network
One of the biggest themes in energy in 2014 is the ascent of the Permian Basin as a source of horizontal drilling. This chart above shows oil production nearly doubling from just 2012 to 2014. If history is any guide, the demand for sand-based proppant in the Permian should grow disproportionately greater than will volume of oil and gas. 

Earlier this week, US Silica acquired Cadre Corporation, a fully integrated logistics and production company with its plant in Voca, Texas, which is about halfway between Austin and the 'capital' of the Permian Basin, San Angelo.

This was an all-cash transaction for $98 million. In return, US Silica will get a processing plant close to the Permian Basin that produces 800,000 tons of fracking sand per year. It will also get a logistics system which is already delivering sand to a full book of Permian Basin customers.

All things considered, US Silica paid only 4.8 times earnings before interest, taxes, depreciation and amortization, or EBITDA, making it a very economical transaction typical of an 'early mover.' Prior to the acquisition, US Silica had only a few rail depot stations in the Permian Basin. The company now has a fully integrated 'system,' by which it has plenty of room to expand upon as Permian oil and gas output grows. 

The plan

Slca Growth Plan

Source: US Silica Investor Relations

The above chart shows US Silica's plan to double EBITDA, between 2012 and 2016. This scenario is represented by the middle line in the table.

Management believes that it can gain 1% market share each year between now and 2016. However, that plan also assumes no acquisitions between now and that date. The Cadre acquisition boosts US Silica's production by a very significant 800,000 tons per year, which, I believe, will put the company closer to the top trajectory. In which case, we should expect EBITDA to grow by over 150% between 2012 and 2016. This is a growth trajectory similar to smaller Permian-focused horizontal drillers such as Concho Energy (NYSE:CXO) and Parsley Energy (NYSE:PE)

What now? 
If you bought US Silica back in the summer of 2013 (which was, by the way, when I wrote my first article on the company), you've done very nicely: Since then, shares have risen from about $22 to $57. Right now, however, US Silica trades at a fairly high 40 times earnings. In my opinion, it is best to wait for a pullback at this time, but US Silica is definitely a name that belongs on your watch list, especially if you believe in the shale. However, if US Silica can indeed grow earnings by 30%-40%, as the 'high' scenario indicates, the company is still reasonably priced with a price to earnings growth ratio of around 1.

Foolish takeaway
US Silica made a great early move into a basin that is likely to take its place alongside the Bakken and Eagle Ford. However, the stock right now is trading at 40 times earnings and it may be best to wait for a pullback on this one. Still, I believe that a high-quality grower such as US Silica deserves a place on your watch list. 

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Casey Hoerth has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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