It was pretty much assumed that Covia Holdings (CVIA) wasn't going to have a great third-quarter earnings report. Even though the combination of Fairmount Santrol and Unimin meant a larger, more diversified minerals and aggregate producer, the sharp decline in demand from the oil and gas sector that started back in July was inevitably going to have an impact on the quarter.
It's hard to put too much of a positive spin on Covia's most recent report, but the nice thing is that the results aren't as bad as they appear. Let's take a look at Covia Holdings' Q3 report to see if the 76% decline in share price since the merger back in June is reflective of the company's future.
By the numbers
The merger between Fairmount and Unimin was completed in June of this year, but for comparison's sake, the reported numbers here are on a pro forma basis for prior quarters.
|Metric||Q3 2018||Q2 2018||Q3 2017|
|Revenue||$523.4 million||$712.4 million||$347.8 million|
|EBITDA||($67.7 million)||$97.3 million||$145.6 million|
|Net income||($288.8 million)||$19.8 million||$30.1 million|
Even before Covia announced results this past quarter, investors already knew that earnings would be down quite a bit from the prior quarter. Not only had its peers posted less-than-stellar results a few weeks prior, but management had also said in a press release that it intended to idle operations at several of its facilities to reduce total output by 3.3 million tons per year in response to market demand. In the third quarter, Covia said that it would idle an additional 1.6 million tons of production capacity this year.
Another thing to keep in mind with these results is that the company had about $295 million in pre-tax impairments related to the merger and restructuring, goodwill on the balance sheet, and the discontinuation of its high-purity quartz business. Absent these charges, adjusted EBITDA for the quarter was $287 million.
One of the reasons that Unimin and Fairmount combined is that it diversified revenue streams for the two business. Unimin got more access to one of the higher-growth segments of aggregates and sand, while Fairmount picked up a more stable business that didn't go through such wild ups and downs. The reason for the merger showed up immediately in the company's segment earnings, as its steady industrial business helped to offset the decline in energy.
What management had to say
In Covia's press release, CEO Jenniffer Deckard explained why the company is seeing a decline in demand for its frack sand and what it is doing to manage the current downturn.
Exhaustion of operator budgets led a progressive slowdown in proppant demand, which is expected to continue through the end of the year before rebounding. At the same time, in-basin supply continued to grow, resulting in significant volume and pricing pressure. We also experienced some specific Energy customer challenges and had limited production from our new in-basin facilities during the third quarter.
We have taken significant actions to further strengthen Covia's leadership position, including the idling of excess capacity and the consolidation of production into our lowest-cost plants, resulting in a more highly competitive footprint. Additionally, our eight million tons of in-basin capacity is consistently ramping up to meet strong demand for this product. These actions better align our product offering with current market demand, and reduce our overall cost to serve. Further, we are making steady progress in strengthening and diversifying our customer mix, partnering with leading last-mile solutions providers, capturing merger-related synergies and growing our high cash-flow-yielding Industrial business.
Tough start for the newly combined company
Frack sans supplier stocks continue to get absolutely hammered by this slowdown in drilling activity. Volumes are down, but prices are way down and killing profitability. Unlike some of its competitors that have large last-mile logistics footprints that help companies garner more long-term supply contracts and better pricing, Covia doesn't have these assets as part of its business and has to rely upon third parties, which means it is much more subject to the commodity price of sand.
The good thing is that it has the steady hand of its industrial segment to now see it through these tougher times. It should help maintain a certain level of profitability that can cover interest payments and keep it out of the solvency issues Fairmount Santrol faced during the last downturn in sand demand.
Fortunately, most signs point to this drilling activity downturn being much more short-lived than the prior one. U.S. production is constrained by infrastructure and takeaway capacity, but companies are building pipelines and other transportation methods as fast as possible to bring crude oil, natural gas, and natural gas liquids to market. Once this infrastructure is up and running, chances are producers will get back to fracking wells and increasing their sand demand.
If the industry dynamics play out like that, then shares of Covia seem incredibly cheap. Its stock currently trades at 0.6 times tangible book value despite the combined company being in a much stronger position than Fairmount Santrol was in the last time the frack sand market fell through the floor. Things could get worse in the next couple of quarters, but this sell-off seems a bit overblown.