U.S. Silica Holdings: Is It #2, A 'Big Guy' Or What?

May. 9.13 | About: U.S. Silica (SLCA)

In March 2012, Portable Plants and Equipment stated:

"Companies can't process enough sand to meet fracking demand".

At the time, there were 68 companies processing fracking sand. The demand created an industrial boom of sorts. But, just a year later, the dilemma regarding fracking sand for the oil and gas industry isn't actually about supply. Rather, the dilemma is transportation.

Not just any sand can be used as fracking sand for oil and gas proppants. The American Petroleum Institute has set fracking sand specifications for roundness, crush resistance and pressure resistance. White quartz sand is the most preferred by fracking companies. Even with such requirements, the major players in the silica (industrial sand and gravel) business report "decades of verified reserves".

Statistics from the United States Geological Survey (USGS) in January 2013 exhibit the boom in the industry. In 2011, 43.7 million tons of silica was produced. Of that total, 39.7 million tons were consumed with approximately 41% used for fracking or 16.3 million tons. In 2012, even though numbers aren't completely validated, estimates show 49.5 million tons of silica produced. Of the 45.1 million tons consumed, the fracking usage swelled to 57% or 25.7 million tons. The fracking consumption in 2012 represents a 57% increase over 2011's usage.

As can happen, booms create gluts. The number of active producers is now 87. Whether it be Seeking Alpha contributors or the Wisconsin Watch, predictions are now that supply has, at least, met demand if not exceeded it. Tom Beekman's research with the Wisconsin Department of Transportation predicted:

"the nationwide demand for frac sand is likely about 40 million tons a year".

He further explained:

"The companies that have managed to put large processing plants on the rail lines average about 1.5 million tons a year. Twenty to 25 of these big locations could meet the national demand. The big guys will provide the market with what they need."

Except for U.S. Silica Holdings (NYSE:SLCA) and Hi-Crush Partners (NYSE:HCLP), the companies providing fracking sand in the industrial sand and gravel industry are privately-held. U.S. Silica conducted its initial public offering in January 2012. Yet it is a mature company with over 112 years of history. U.S. Silica claims it is the second largest producer of commercial silica in the United States. Hi-Crush Partners is a master-limited partnership that went public in August, 2012. Hi-Crush operates primarily in Wisconsin. The other major national players are Fairmount Minerals, Unimin Corporation, Badger Mining and Preferred Sands.

So, the pertinent question for investors in U.S. Silica is whether it will be one of the "big guys providing the market with what they need". U.S. Silica has 307 million tons in reserves. Of the 307 million, 144 million could be processed to meet API frac specifications. But, remember, supply is not the question anyway.

Transportation is the major contributing factor in the cost of fracking sand. Rail access is key. The Oil and Gas Investment Bulletin reported a shortage of rail cars in February 2012. A rail car's capacity for fracking sand is around 100 tons or 200,000 pounds. Averaging the transportation of 40 million tons of fracking sand over a year's time would equate to the usage of over 30,000 rail cars per month.

U.S. Silica has access on the BNSF, Union Pacific, CN, CP and CSX railways. Its strategically-located facilities provide rail access to major U.S. shale basins. As of December 31, 2012, U.S. Silica had a leased fleet of rail cars numbered at 1,597. In its annual report, U.S. Silica stated it is negotiating for additional cars yet believes it will have access to a sufficient supply for 2013. By comparison, Fairmount Minerals has 3,000, Preferred Sands has 4,000 and Unimin has more than 5,000.

After the issue of transportation, storage arises as the next challenge. Transloading is the process of transferring a shipment from one mode of transportation to another. U.S. Silica uses the term "transload" to include the storage silos and loading equipment at its rail terminals in the shale basins. By year-end 2013, U.S. Silica plans to have 25 to 30 transload locations. Fairmount Minerals has 39 such distribution terminals, Unimin has 21, and Preferred Sands has 54.

So far, by both counts - rail car supply and storage, U.S. Silica isn't measuring up in the #2 spot. Of the $441.9 million in U.S. Silica's revenue for 2012, $243.8 million or 55% was generated from sales of fracking sand used for oil and gas proppants. U.S. Silica shipped approximately 3 million tons of proppants in 2012. Year-over-year revenue for proppants from 2011 to 2012 grew 128% for U.S. Silica. Earnings per share grew 64% from $0.88 in 2011 to $1.44 in 2012.

The domestic growth demand for industrial silica for fracking sand is projected at 8% annually through 2016. Analysts predict an EPS long-term growth estimate of 40% for U.S. Silica. However, industry projections of 20% annual EPS growth may be a more practical measure to guide U.S. Silica investors.

Tell-tale signs may have emerged in U.S. Silica's 2013 first quarter earnings miss. While the quarter's revenue in the oil and gas proppants segment grew 37% year over year ($73.6 million vs. $53.8 million) and shipment tonnage increased 36% (920,569 vs. 678,982), income in the segment only increased 3% ($36.2 million vs. $35.1 million). The average price per ton in the first quarter of 2013 of $79.95 ($73.6 million/920,569) is actually higher than the 2012 first quarter average of $79.24 ($53.8 million/678,982). U.S. Silica's costs obviously outpaced revenue growth.

There are other factors worth consideration regarding U.S. Silica. It operates another business segment, industrial and specialty products, that contributes 40% of its revenues. Serving the housing, chemical and automotive industries, this segment contributes much lower margins to U.S. Silica's bottom line. But, it does expect to see some growth in this segment as it develops product and expands globally.

Capital expenditures for 2013 are projected to be $50 million to $60 million. These expenditures are front-end loaded with already $22.7 expended in the first quarter. First quarter investments were made in a processing plant, an acquisition and construction of transload sites. U.S. Silica has cash and cash equivalents of $42.9 million. However, only $29 million is available under its credit facilities. Long-term debt totals $265.4 million.

Interestingly, U.S. Silica elected to establish a regular quarterly dividend in the first quarter. It did pay a special dividend to shareholders in December, 2012 of $0.50 per share. The 2013 annual rate is also set at $0.50.

The need for fracking sand is no longer the primary market driver as supply has met and perhaps even exceeded demand. The transport and storage of fracking sand are now the market drivers. While U.S. Silica claimed the #2 spot in the industry, the supporting data does not validate its claim. Even though it is probably not the #2 player in the industry, U.S. Silica does easily portray it is one of the "big guys".

As another major shift begins in the industry, most likely toward consolidation, investors in U.S. Silica would be wise to decide whether they are looking for an aggressive growth stock or a maturing dividend-paying industry anchor. It is not likely U.S. Silica will be or even can be both.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.