Most investors already knew that fracking sand supplier U.S. Silica Holdings (NYSE:SLCA) was going to face some challenging industry headwinds to end 2018. Oil prices were dropping quickly, most producers exhausted their annual capital budgets early, and there was limited takeaway capacity for additional production across most of North America.
It was pretty much a foregone conclusion that the company was going to see earnings decline and probably slip into the red. Fortunately, it was able to rely on higher-margin services such as its logistics business and its segments other than oil and gas to soften the blow this past quarter.
Let's look at U.S. Silica's most recent earnings results, what management is focused on in 2019, and what that will likely mean for investors for the rest of this year.
By the numbers
|Metric||Q4 2018||Q3 2018||Q4 2017|
|Revenue||$357.4 million||$423.2 million||$360.5 million|
|Operating income (loss)||($274.1 million)||$25.7 million||$48.8 million|
|Net income||($256.1 million)||$6.3 million||$71.9 million|
U.S. Silica's large loss this past quarter was attributed mainly to several impairments and other one-time charges that totaled $289 million. Some of those charges were noncash, such as the $265 million goodwill impairment; others were attributed to plant start-ups and merger & acquisition activity. Stripping out these one-time effects, management said its adjusted fourth-quarter loss was around $0.04 per share.
According to management, it wrote down a large portion of its proppant business, primarily from its Northern White sand production facilities in the Upper Midwest. As more and more companies look to use in-basin supplies with lower transportation costs and much shorter transit times, Northern White sand sales have suffered.
The good news is that the company was still able to produce decent operating results. Even though the struggles of its oil and gas proppant segment were well documented coming into this quarter, it was still able to produce a contribution margin of $54 million thanks to long-term contracts and its last-mile logistics services, SandBox. Management noted that thanks to SandBox, it has captured 24% of the hydraulic fracturing-sand market and expects more in the coming months.
It also helps that the company significantly expanded its industrial and specialty product (ISP) segment by acquiring EP Minerals in May of last year. Adding this segment gives the company a more steady business that helps to offset the volatility of the oil and gas industry.
What management had to say
One thing has become apparent over the past few years: Shale drilling in North America is an incredibly volatile business, which means that sand demand (and prices) can be incredibly hard to predict. Because of this dynamic, U.S. Silica's focus over the past few years has been to find ways to stabilize revenue and margins through the cycles.
The two ways it has done that is to invest heavily in its logistics services and to expand its ISP business. Between the end of the fourth quarter and its recent earnings report, the company announced it had signed up Chesapeake Energy to a long-term sand supply and logistics contract, and that it will retool a recently acquired ceramic proppant facility to manufacture products in its ISP segment.
On the company's conference call, CEO Bryan Shinn went into detail about why these two segments will be management's priorities for 2019:
We expect to continue with our strategic plan to substantially grow our Industrial segment by focusing on Specialty Minerals and Performance Materials offerings. We plan to launch and expand the sales of several new offerings this year while growing the underlying base business through GDP [growth] plus market expansion and continued price increases.
For example, we see an increased market penetration for some of our higher-growth products like White Armor, an industrial roofing product that is in very high demand, and both legacy ISP and EP Minerals have announced price increases for 2019 in the range of 2% to 9% depending on the product and the grade.
I'm also very excited about the prospects for SandBox in 2019 and beyond. Our existing equipment is 100% sold out for 2019, and we're building new equipment as fast as we can to meet very strong customer demand. Many of our existing and new customers are embarking on substantial high-efficiency well-completion programs and believe that SandBox is the only system that gives them the required combination of efficiency, flexibility, low [nonproductive time], and the throughput capacity to achieve their objectives.
Better positioned to handle volatility
It's understandable that many investors don't want any part of a company so exposed to a market as volatile as frack sand, which likely explains why the company continues to trade at a modest P/E of 10. That said, management has done a commendable job of taking out much of the variability inherent in this business with its investment strategy. Unlike the last sharp decline in sand volumes, the company was able to hang on to modest operating profits for its proppant business.
The good news is that the business is expected to pick back up again in the second half of 2019. Additional takeaway capacity in key shale basins such as the Permian means producers can increase their well completions, which requires more sand. Also, the company has two major in-basin sand mines that already have takeaway contacts in places set to ramp up production in 2019.
It may take some time for the market to catch up to these events, but it's pretty clear that U.S. Silica is on a relatively sustainable path that should result in consistent profitability and the ability to keep rewarding shareholders with a modest dividend and share repurchases. If we see demand for sand pick back up again, don't be surprised if U.S. Silica's shares go up with it.