On Tuesday, October 27, U.S. Silica Holdings (NYSE: SLCA) released third-quarter earnings results that were far from pretty. Yet the next day, Wall Street rewarded the stock by sending shares soaring 22%. In my opinion, the market's reaction to U.S. Silica's earnings was well justified. That's because this quarter's results prove that U.S. Silica is now the frack sand stock most likely to survive the oil crash, no matter how long it lasts.
Results themselves are rather ugly but contained some good news
U.S. Silica's year-over-year results were abysmal. However, compared to last quarter, volumes, sales, and margins actually improved. Wall Street seems most impressed that U.S. Silica was able to earn a small profit (thanks to a onetime tax benefit) compared to its expectations of a -$0.01 per share loss.
Then again, long-term investors know that what really matters isn't a piddly profit over a single three-month period, but a company's underlying business model and ability to adapt to challenging industry conditions.
As President and CEO Bryan Shinn pointed out, "We took decisive actions during the quarter to profitably sell higher volume in our Oil and Gas business and take share.''
Specifically, Shinn is referring to the fact that U.S. Silica was able to increase the volume of frack sand sold this quarter by 32% compared to last quarter, indicating that it's successfully winning market share from competitors.
Industry consolidation heating up
What's important to note is that those market share gains are not from US Silica's largest competitors but rather smaller sand producers who are being forced out of business or acquired. This industry consolidation has allowed US Silica, Hi-Crush Partners (NYSE: HCLP), Emerge Energy Services (NYSE: EMES), and Fairmount Santrol (NYSE: FMSA) to double their combined market share over the past year to 66.3%.
Why is size such an asset during the oil crash? For one thing oil and gas companies usually prefer to do business with just a few large suppliers that can deliver sand to several different areas of the country and right to their rigs operating in basin. This makes a large and complex transportation infrastructure a valuable competitive advantage that smaller sand producers just can't match.
Another key factor leading to consolidation is that the larger you are the easier time you have negotiating with suppliers to extract price breaks and minimize production costs in these dark industry times. As Emerge Energy CEO Rick Shearer stated during the most recent earnings call, "We continue our relentless work to gain lower shipping rates, trucking rates, supplier and contractor rates."
Finally, larger frack sand suppliers, due to their valuable assets, are able to obtain easier financing and their creditors are more likely to offer help in the form of waiving certain debt covenant obligations that can force smaller sand producers into bankruptcy.
In US Silica's case the company also has the benefit of diversification via its industrial and specialty sand division (ISP), which reported record results this quarter. In fact ISP's 19% year-over-year increase in contribution margin is a testament to U.S. Silica branching out into higher margin specialty products especially those involving auto manufacturing and construction.
These non-oil related cash flows can also help US Silica strengthen its balance sheet and potentially leave it in the driver's seat when it comes to even more aggressive industry consolidation.
A strong balance sheet could leave U.S. Silica one of the last sand producers standing
US Silica's management is hunkering down for the long haul, but luckily for investors its balance sheet shows that the company is best positioned among its peers to ride out what might prove to be several years of low oil prices.
|Company||Cash||Debt||Current (Liquidity) Ratio||TTM EBITDA/TTM Interest Cost|
|US Silica||$300 million||$493 million||4.9||5.5|
|Hi-Crush Partners||$5 million||$252 million||2.9||3.7|
|Emerge Energy Services||$6 million||$273 million||2.6||5.7|
|Fairmount Santrol||$180 million||$1.241 billion||3.9||3.5|
You can clearly see that U.S. Silica's cash position is by far the strongest of the major frack sand producers. Perhaps more importantly U.S. Silica's debt is in the form of a term loan due July 23, 2020.
Hi-Crush Partners, Fairmount Santrol, and Emerge's debt includes credit revolvers that come with debt covenants that require minimum debt-to-EBITDA ratios that U.S. Silica doesn't have to worry about. All its creditors care about is that it can continue making interest payments.
US Silica's industry leading financial position and diversified cash flows from its ISP segment mean not only is it best able to survive this industry downturn, but potentially even consolidate one or more of its larger competitors and thus gain enough market share to truly dominate the frack sand industry in the years to come. Specifically, during its latest conference call Emerge Energy mentioned that it was considering different strategic initiatives, including an all stock "merger of equals" with another major frack sand producer.
In my opinion, such a deal would most naturally fit with US Silica, which has both the substantial cash reserves and strongest liquidity to help the more heavily indebted Emerge survive until oil recovers.
Bottom line: frack sand industry in for tough times, but U.S. Silica is best suited to pull through
No one can predict when oil prices, and thus the frack sand industry, will start to recover. In fact, during its earnings release, Hi-Crush Partners warned investors that the fourth quarter is likely to see sand demand and prices falling further. Meanwhile, Emerge Energy is now saying a recovery isn't likely until the second half of 2016, or even 2017 .
U.S. Silica's strong balance sheet, large cash war chest, and lack of debt covenants means it has not only the best chances of surviving the oil crash, but is best suited to growing its already industry leading market share by acquiring distressed competitors, potentially even one of the other three dominant sand producers.