U.S. Silica Holdings (NYSE:SLCA) has long been the standout company in the frack sand business. Its size and financial strength allowed it to weather the drop in oil prices better than its peers and positioned it well for the recent growth phase. This past quarter, the company expanded its universe by acquiring another mineral mining business, but it is taking some risk in doing this. Thankfully, demand for frack sand remains high, as evidenced by the company's most recent earnings results.
Here's a brief rundown of U.S. Silica's most recent earnings report, some of the details around its most recent acquisition, and what investors should be looking for through the rest of the year.
By the numbers
|Metric||Q1 2018||Q4 2017||Q1 2017|
|Revenue||$369.3 million||$360.5 million||$244.8 million|
|Operating income||$45.2 million||$48.8 million||$13.4 million|
|Net income||$31.3 million||$71.9 million||$2.5 million|
Compared to this time last year, U.S. Silica's results look fantastic. Then again, a lot has happened in the past year, so investors should expect considerably better results. The total volume of sand sold is up 22% to 4.12 million tons, and operating income more than tripled to $45 million. If there's one thing to get picky about with these results, it's that operating costs increased faster than revenue growth compared to the prior quarter, which led to the slight decline in operating income. (It's not worth looking too deep into the sequential net income results, because U.S. Silica included a $35.8 million tax benefit related to changes in U.S. tax rates).
Another thing worth noting is that the company's sand logistics business, SandBox, continues to improve performance for its oil and gas proppant business. According to management, companies using its Sandbox service have seen a 76% decrease in delivery and load times for frack sand. This speed advantage is a large reason why management was able to increase its in-basin sand sales to 67% in the quarter compared to 62% last year (in-basin sales are higher-margin sales for U.S. Silica).
It's worth noting that this quarter's results do not include the results from its most recent acquisition. On March 23, management announced it acquired diatomaceous earth company EP Minerals for $750 million. The addition of EP Minerals is expected to about double the contribution margin from non-oil and gas proppants and create another business line that smooths out the cyclicality of serving the oil industry, as diatomaceous earth is commonly used in a variety of end markets including water filtration, pet litter, agriculture, biofuels, and hazardous-spill cleanup. The deal is expected to close in the second quarter.
What management had to say
In the company's press release, CEO Bryan Shinn highlighted the addition of EP Minerals and the strategic advantages it will give the company over the long haul, and provided a brief rundown of its oil and gas business:
I'm very pleased with our strong first quarter results and the progress we made in advancing our top strategic initiatives, including our acquisition of EP Minerals, which I believe will grow and diversify our earnings stream and create additional value for our shareholders.
Our Oil and Gas business sold record tons during the quarter, made good progress in building out our West Texas expansions and signed a number of new long-term supply agreements. Our Sandbox unit also performed very well during the quarter, with contribution margin up 23 percent, driven by higher volumes, lower costs and targeted price increases.
U.S. Silica looks good, but one question remains
In 2017, U.S. Silica went into full-blown growth mode by acquiring a competing sand mine and building two new mines in West Texas to serve the Permian Basin. The addition of EP Minerals is a clear sign that management wants to keep growing the business, but it is a different track than the company has been taking as it helps to diversify away from its oil and gas business.
Strategically, adding a new business line with significant overlap to its industrial and specialty product should make this an easy business to incorporate. The question is how well the company will be able to handle the financing of the deal. Management elected to restructure all of its existing debt and pay for this acquisition with a $1.2 billion term loan. Which, if we add EP Minerals to the income statement, will give U.S. Silica a debt-to-EBITDA ratio of 2.5. That isn't necessarily a huge red flag, but U.S. Silica will immediately go from having one of the leanest balance sheets to one of the most bloated among frack sand suppliers.
With a large portion of its expansion plans in place, though, the company should be able to throw off enough cash to bring that debt level back down and potentially start returning some of that cash to shareholders. After several years of middling returns, that would be a welcome change.