On paper, it looks like frack sand supplier U.S. Silica Holdings (SLCA 0.85%) had a pretty tough quarter. Even though sales were up significantly, its income numbers fell off a cliff compared to this time last year. That seems to fly in the face of what's going on in the oil and gas industry, where production is still growing, and demand for services, equipment, and materials remains high.
Fortunately for investors, U.S. Silica's headline numbers don't tell the whole story. So let's dig a little deeper into the company's results.
By the numbers
|Metric||Q2 2018||Q1 2018||Q2 2017|
|Revenue||$427.4 million||$369.3 million||$290.4 million|
|Operating income||$39.6 million||$45.2 million||$44.0 million|
|Net income||$17.6 million||$31.3 million||$29.4 million|
This was one of those quarters where one-time expenses and non-cash writedowns had a rather profound impact on the bottom line. Included in those income numbers are more than $44 million in one-time expenses related to closing its recent acquisition of EP Minerals, expansion costs for one of its sand mines, and a writedown of its resin-coated sand business. Adjusting for all of these one-time expenses, earnings per share would have been $0.64 per share. Those adjusted results were still below Wall Street's expectations, though.
Both of the company's business lines delivered considerable gross profits this past quarter (what management calls contribution margins). On the oil and gas proppant side, volumes were up 9% sequentially from new capacity additions, and contribution margin was up 30% sequentially on better pricing and expansion of its Sandbox last-mile logistics service. Its industrial and specialty products benefited from the addition of EP Minerals as well as some higher pricing management passed onto customers. Keep in mind that the EP Minerals deal closed in May, so this was only a partial look at what this acquisition will add on a quarterly basis.
What management had to say
In U.S. Silica's press release statement, CEO Bryan Shinn gave management's rationale for exiting its resin-coated sand business and why it decided to take the writedown this past quarter.
During the quarter we also decided to exit the resin-coated sand business, which primarily served the oil and gas market, based on customer feedback that demand for this type of product is rapidly declining. This has been a very small business for us and we don't anticipate any impact to earnings beyond the impairment charges in the second quarter.
Shinn also gave an outlook for the rest of the year and how it will affect the bottom line:
[W]e expect strong demand in Oil and Gas for both sand and Sandbox. We are heavily contracted in this market at attractive margins and are well positioned to serve our blue-chip customer base in the years ahead. In ISP [industrial & specialty products], we expect significant margin growth from pricing, new products and accretive acquisitions. Given these many positive catalysts, we should generate substantial free cash flow in the coming quarters, with free cash flow yield approaching 15% at our current market capitalization next year.
Emphasizing the growth potential in its oil and gas segment, U.S. Silica expects volumes to grow 20% to 25% from ramping up capacity at new facilities and expansion projects. 80% of all of its volumes are now contracted under long-term supply agreements.
Wall Street may not like one quarter, but things are looking better by the day
You know that old adage, "buy the rumor, sell the news"? Well, it appears that Wall Street is buying on promises and selling on performance. U.S. Silica's business has vastly improved over the past year, yet its stock is down 20% year to date. That doesn't seem to jive with all of the improvements U.S. Silica has made to increase volumes, grow margins with logistics services, and diversify its business with more investments in industrial and specialty products. If the 25% volume increase for oil and gas and the higher prices for ISP come to fruition in the third quarter, then we should see a huge uptick in earnings.
If there is one thing concerning from an investor's perspective, it's U.S. Silica's increasing debt load. With the acquisition of EP Minerals, it increased its total debt to $1.2 billion. That isn't the end of the world, per se, but one of the issues the frack sand industry ran into a couple of years ago was being debt-heavy as demand started to slip. Management feels comfortable enough with its debt levels that it initiated a $200 million share repurchase program, so perhaps it's simply something to watch in the coming quarters.
I can't say with any certainty what Wall Street will do with this stock in the short run, but U.S. Silica's operations are on a whole different level than they were before the oil price crash a few years ago, and the company looks well positioned to generate considerable earnings and cash over the next few years. With shares trading at a price-to-earnings ratio of 12.1, the stock is looking pretty attractive.