It might be difficult to believe that anything has performed worse than crude oil in the past six months, especially considering the doom and gloom media and analyst coverage, but U.S. Silica Holdings (NYSE:SLCA) stock has pulled off the impossible. The price of West Texas Intermediate crude has dropped nearly 43% in the last half-year, while shares of the proppant and ceramic supplier have been whacked by 52%.
Judging by the chart above, Wall Street expected the worst possible finish to 2014. It makes sense at first glance. The significant drop in oil prices has forced oil and gas companies to rein in capital expenditures for the year ahead, which has already resulted in subdued expectations for well count growth. That should have a big impact on any company that relies heavily on drilling activity, such as U.S. Silica, which captured 63% of its revenue and 72% of gross profit from the oil and gas sector in 2013.
We'll find out today if those worries are completely justified when the company reports 2014 earnings, but there are solid reasons long-term investors -- and even those with a short-term mind-set -- shouldn't be too worried. Here's why.
Solid financials and long-term contracts
Will there be challenges in the year ahead? Absolutely. Did U.S. Silica deserve to have its stock slashed in half in the last six months? Maybe investors got a little carried away last August when shares topped $70, but I think the numbers show the recent slide was a bit dramatic.
This week, shares are trading at a trailing 12-month price-to-earnings ratio of 16. However, that number is based on TTM earnings per share of $1.93, which still includes fourth-quarter 2013 EPS. Should the company meet the average analyst estimate for fourth-quarter EPS of $0.74 its TTM EPS would rise to $2.44, according to Yahoo! Finance. The company's P/E at the current share price would drop to just 12.7. That's a steal compared to P/E ratios investors have willingly gobbled up shares at in recent years.
Of course, investors are more worried about future growth. Won't that be decimated?
Let's not forget that 70% of U.S. Silica's proppant sales (the sand sold for fracking applications) are under contract at healthy margins to some of the industry's leading companies. The remaining 30% of sales that rely on spot market sales will be threatened in a low price oil environment, but investors shouldn't be so shortsighted.
Consider that U.S. Silica achieved a new watermark for annual revenue in the first half of 2014, as well as a new high in annual operating income in just the first nine months of the year. Through the first nine months of 2014 the company's revenue and operating income were 48% and 45% higher, respectively, than the performance achieved in all of 2013.
It's also important to remember that over one-third of revenue and roughly 30% of earnings are generated from the company's industrial and specialty products segment, which sells high-quality sand to industrial customers as the raw material for ceramics, paints, and other important products. The platform's top five customers have contracts that span over 50 years each! And to think so many investors are worried about what happens in the next 12 months.
Growth deferred, not denied
While I think the market is getting carried away with worst-case scenarios, investors will likely need to lower the bar for near-term growth guidance or, more accurately, extend their time horizons by a year or two. By 2017, U.S. Silica had planned on growing sand production to 7.5 times the level achieved in 2011. Similarly, the company expected to grow annual EBITDA from an estimated midpoint of $235 million in 2014 to roughly $575 million in 2017 by relying heavily on its proppant business.
I wouldn't be surprised to see management add another year onto its self-imposed deadline for reaching those targets. Then again, it's still possible for U.S. Silica to stay on previously guided timelines if oil prices rebound and drilling activity in shale basins resumes, even if a detour must be taken in 2015.
Don't freak out
The company might be more realistically priced, but now it's likely too cheap for future growth. Remember, U.S. Silica stock didn't fall from grace because of competition, management being irresponsible with cash, or some existential threat to its business. It dropped because the market perceived a detour in the company's long-term growth as the end of the road.
Sure, 2015 will be a challenging year for oil and gas suppliers, and the headwinds will persist for as long as a low price oil environment remains in place, but industry leaders will rebound with oil prices. U.S. Silica owns 366 million tons of raw sand reserves (enough for 40 years at current production levels) standing at the ready to enable continued growth opportunities for shareholders; operates near some of the world's most abundant fossil fuel reserves; and provides real, tangible value to its customers. The next few quarters might be uncomfortable, but there's no good reason for long-term investors to walk away now. Don't freak out.