With oil prices setting new lows, investors in oil stocks such as US Silica Holdings (SLCA -1.72%) are getting nervous about the company's growth prospects. That's perfectly understandable given that the number of US oil rigs in operation is currently at its lowest level in four years which has caused demand for frac sand to decline sharply.
US Oil Rotary Rigs data by YCharts
Luckily for US Silica investors there are three facts that should help the company weather the oil crash and achieve long-term success.
Industrial & Specialty Products is a silver lining during this oil downturn
Throughout most of the company's 100-plus-year existence, US Silica was known for its industrial sand products used in the automotive, glass, chemical, metals, and construction industries.
| Metric (% of Company Total) | Oil and Gas | Industrial and Specialty Products (ISP) |
|---|---|---|
| 2014 Revenue | $663 million (76%) | $214 million (24%) |
| 2014 Contribution Margin | $256 million (81%) | $61 million (19%) |
| 2014 Sand Volume | 6.7 million tons (61%) | 4.2 million tons (39%) |
Source: US Silica investor presentation.
While true that most of company's sales, volumes, and profits are derived from the oil industry, the ISP segment provides a source of diversification and growth that most of the company's competitors can't duplicate.
In fact, according to Bryan Schinn, US Silica's president and CEO, during the second quarter the ISP segment generated record contribution margin, up 11% year over year and 26% greater than last quarter.
The impressive growth is courtesy of "a combination of increased sales from new higher-margin products, market-share gains, new business opportunities, and healthy end markets for many of our products."
In fact, thanks to two industries in particular -- automotive and residential construction -- management is bullish about continued strong growth in this business segment in the quarters ahead.
US Silica is waging a battle for market share
While US Silica's ISP segment may be doing well, there's no way to sugarcoat the negative impact the oil crash has had on the company's main cash cow.
According to Schinn, with the number of oil rigs down 57% since June 2014, when oil was at its peak, "Lower pricing, lower volumes, and decreased fixed cost leverage drove Oil & Gas contribution margin per ton, down 65% sequentially to $10.83 per ton. More than half of this sequential decline was driven by price and about one-third resulted from decreased fixed cost leverage."
Since US Silica started the year with over 70% of 2015's production under contract, why are margins being hammered so severely? The answer is that management is taking a longer-term view and allowing its customers to renegotiate lower sand prices in exchange for increased future volume concessions.
In my book, a willingness to help oil producers survive the oil crash is a great way to not only protect market share -- as US Silica is doing -- but also to generate improved customer relations that could pay handsome dividends when oil prices finally recover. Better yet, management is hard at work cutting costs to the bone while ensuring continued cash flow flexibility and keeping an eye on future growth.
Massive cost reduction effort under way
Management's plan for weathering the oil downturn is twofold. In addition to maintaining or even growing market share via price concessions, it's also scouring its supply chain for ways to minimize costs and maximize fixed cost leverage -- in other words, spread out substantially reduced expenses to decrease costs per ton of sand produced.
In fact, according to Schinn, US Silica has 200 cost-reduction projects under way, including a major focus on cutting transportation and logistics expenses. Specifically, the company recently pushed back delivery of 2,500 rail cars until 2017 and 2018, as well as securing pricing and contract concessions from many of its suppliers.
Overall, the company is on track to cut overhead costs 20% relative to its previous 2015 budget while still completing four production and transportation projects that will help increase its low cost sand production and distribution capability in the future.
Bottom line: The oil crash pain may not be over, but US Silica's long-term prospects remain bright
US Silica has fallen 63% in the past year, and I wish I could tell you that the worst is probably over, but the truth is that I can't. No one can predict oil prices in the short to medium term, and US Silica's stock may have further to fall.
However, in my opinion, US Silica's strong management team is making all the right moves to ride out the oil crash. More importantly, these actions help prepare the company to take advantage of America's remarkable shale oil and natural gas future.
Thus, I would recommend that US Silica investors take the long-term view and prepare for crude's eventual recovery by harnessing the incredible power of dollar-cost averaging. By adding shares over time -- especially while Wall Street is at its most bearish about all things oil -- you maximize your chances of market-crushing total returns in the years to come.
