Birkey Investment Fund
U.S. Silica Holdings
Tim Palmer, Aaron Collins Michael Woolf
This document provides a company analysis for U.S. Silica Holdings and an investment recommendation.
U.S. Silica Holdings (SLCA) is an up-and-coming company that has a promising future. It operates in the sand and gravel mining industry and it is experiencing an increased demand for its products. U.S. Silica is a large influence in an industry that is competitive through many local companies. Environmental regulations are a potential issue, due to oil fracking which is its most profitable business. U.S. Silica is taking steps to improving its business through these regulations. It also has a constant revenue from its other sector which provides silica for industrial use. Steadily increasing revenue and earnings trends show possible growth in the company. Other financials, such as forward P/E also show that there is promise in U.S. Silica.
Figure 1- Map of U.S. Silica Operations throughout the U.S.- Source 10 K
Sand and Gravel Mining Industry Analysis
Sand and gravel mining revenue is forecasted to grow at an annual rate of 5.4% from 2013 to 2018 (IBIS Industry Report). The growth in the demand for sand can be attributed to the popularity of hydraulic fracking. U.S. Silica Holdings, Carbo Ceramics, and Hi-Crush LP are included in this industry.
U.S. Silica Holdings (SCLA) is a miner and refiner of industrial minerals focusing on sand and various types of silica. It also operates as a research and development specialist for products using its raw materials. SLCA is one of the largest domestic producers of commercial silica, a specialized mineral that is a critical input in the oil and gas proppants end market. It is part of the Russell 2000 Small Cap Index in the Basic Materials sector and the Sand and Mining Industry. It provides products that are used in a variety of industries such as oil and gas, glass, chemicals, foundry, building products and recreation. Approximately sixty-two percent of its sales in 2013 have come from the oil and gas proppant segment which is the area emphasized in this analysis. The company is located in 13 states across the U.S. and also in China with headquarters in Frederick, Maryland.
U.S. Silica Holdings, Inc. operates in 2 segments: Oil and Gas Proppants and Industrial & Specialty Products. Its commercial silica products are used as fracturing sand in connection with oil and natural gas recovery. Its industrial and specialty products division produces various size distributions, grain shapes, and chemical purity levels for manufacturing glass products. It also provides ground commercial silica products for use in plastics, rubber, polishes, cleansers, paints, glazes, and textile fiberglass, and fine ground silica for use in premium paints, specialty coatings, sealants, silicone and rubber. U.S. Silica Holdings was founded in 1901 (YahooFinance, profile).
CARBO Ceramics Inc. (CRR) manufactures and sells resin-coated ceramic and resin-coated sand proppants that are used in the hydraulic fracturing for natural gas and oil wells in the United States and internationally. It primarily sells its products and services to oil and natural gas proppant end markets and oilfield service companies. CRR was founded in 1987 and is based in Houston, Texas (YahooFinance, profile).
Hi-Crush Partners LP (HCLP) operates as a producer of monocrystalline sand, a mineral that is used as a proppant to enhance the efficiency of retrieving hydrocarbons from oil and natural gas wells. HCLP offers raw frac sand used in hydraulic fracturing for oil and natural gas wells. HCLP was founded in 2010 and is based in Houston, Texas (YahooFinance, profile).
Hydraulic Fracking is a main use for the sand that is produced in the Industry. This process accounts for a large percentage of total sales. Fracking is a method of mining for natural gas and oil. This is the process of creating a combination of frac sand, chemicals, and water. After a well has been mined, the mixture of the ingredients is pushed down the mine at a high pressure. The high pressure forms fractures in the mine that allows for the oil or natural gas to escape. The waste water is then sent up into waste wells for disposal. This process uses silica which is produced by U.S. Silica Holdings.
Figure 2- A Diagram of the Fracking Process when Drilling for Natural Gas and Oil. A significant portion of SLCA's revenue comes from providing the sand used in this process.
The production of frac sand is specific to the job. The size of the sand can range from 0.4 to 0.8 mm. The frac sand is held to specific regulations such as a high purity and a spherical shape to avoid resistance while going down the well. The sand acts as a proppant in the mixture produced for the hydraulic fracture. It is high in density which allows the fractures to be held open. The openings then produce the oil and gas.
The sand and gravel mining industry is closely linked to the performance of the macro economy as a whole. The following are some of the most important macroeconomic indicators affecting the sand and gravel mining industry.
Gross Domestic Product
(click to enlarge)The Gross Domestic Product (GDP) provides a valuable indication of how well the economy is performing. The GDP is an important indicator to the sand and gravel mining industry because a mineral like silicate is used in the production of glass for cars or houses. Therefore, when GDP increases, this is a signal that the economy is performing well and consumers are able to purchase cars and houses which will cause the demand for silicate to increase which would help the sand and gravel mining industry. Figure 1 shows that GDP has recovered since the 2008 financial crisis, which has positively impacted U.S. equities in general.
Figure 3- U.S. Real GDP- Source: FRED
Natural Gas and Crude Oil Prices
Commodity prices are very important in the sand and gravel mining industry. Demand for frac sand is closely related to the number of natural gas and oil wells in operation. The number of the natural gas and oil wells is closely related to natural gas and oil prices. If prices of these commodities are higher, then amount of exploration, development, and production for oil and natural gas will increase, and thus the demand for frac sand will increase. The opposite occurs when oil and natural gas prices are low.
Figure 4- Crude Oil Prices 2008-Present- Source Fred
The following chart shows how natural gas and oil prices have recovered since the 2008 recession. Oil prices rebounded sharply during the first 6 months of 2009 and have sustained an uptrend since. Natural gas prices have been sluggish and remained depressed although in early 2012 they have shown signs of turning higher. Companies in the sand and gravel mining industry should benefit if natural gas were to continue to rebound and oil prices maintained a long-term up-trend over the coming years.
Figure 5- Natural Gas Prices 2008-Present- Source Fred
Total Construction Spending
Demand in many of the end markets for commercial silica is driven by the construction industry. End products such as flat glass and silica are used in many areas of the construction industry. As a result, demand for many of the products produced by companies in the sand and gravel mining industry is derived from the amount of construction taking place in the economy.
Total construction spending in the U.S. economy fell sharply following the 2008 recession as the housing market was hit hardest. Housing prices are typically slow to recover due to an extended unwinding period, and the 2008 financial crisis was no exception with the housing market being one of the slowest sectors in the economy to recover. However, since 2011 total construction spending has increased and appears to be on a path of continued recovery. If this continues, then it would benefit most companies in the sand and gravel mining industry.
Figure 6- Total Construction Spending 2008-Present- Source Fred
Oil and Gas Drilling
Much of the growth in the demand for frac sand and proppant can be attributed to the growing number of oil rigs being built. Figure 7 illustrates how after falling sharply in 2008 the number of oil rigs in operation has grown at a steadily increasing rate. Although natural gas rigs have been sluggish due to lower natural gas prices in recent years, the number of oil rigs in operation has been growing at a relatively constant rate. Growth in demand for frac sand that U.S. Silica and its competitors provide to the drilling rigs, has been outpacing rig count growth (Investor Relations Report 2012). This is due to improvements in drilling technology that are making fracking more efficient.
The growing number of rigs being built, combined with an even faster growth rate in demand for proppant, could provide revenue growth for companies in the sand and gravel mining industry that supply oil and gas drilling rigs.
Figure 7- U.S. Land Drilling Rig Count-(Source Investor Relations Report 2012)
Porter's 5 Competitive Forces Analysis
The production of the mining for sand and gravel is heavily controlled by 10 companies. Unimin Corp, U.S. Silica, and Fairmount Minerals are the top three producers in the industry. The top ten companies contribute 72% of the entire U.S. Total. Like U.S. Silica, Unimin Co. has been growing to meet the demands for their product. They currently have 250 mines and plants in 41 countries. A common area to acquire and build mines for these companies is in the Midwest and East of the United States. There has also been a trend in recent years for larger companies to acquire smaller companies in a roll up strategy. U.S. Silica Holdings is the only publicly traded company out of the 10 largest producers of Silica.
Factors Affecting Rivalry Among Competitors
Companies in the sand and gravel mining industry compete mostly at a local level. SLCA is the second largest silica producer in the United States. Because a large portion of SLCA's sales come from fracking customers, there is also has competition from larger companies such as HCLP and CRR. The strength of the rivalry among competitors is moderate.
Within the industrial use of silica there is little differentiation between products in the sand and gravel mining industry. However, in the frac sand market, which has grown rapidly over the previous five years, there has been a large increase in demand for high quality silica because it makes the fracking process more efficient. This means that developed companies that are able to refine frac sand more efficiently than smaller local competitors now have more of an advantage than they did in recent years. Companies try to differentiate themselves through price and quality of their product and reliability of their delivery operations. The transportation network is very important for a company as it influences its ability to keep prices low when transporting materials to customers. Concentration in the industry is low as demonstrated by the fact that the three largest players account for only 21.5% of the industry revenue. This is because it requires vast amounts of capital to cover many regions due to high transportation costs. This makes it important for companies to have quarries located close to its customers. However, there is a trend towards increasing consolidation over the last 5 years, which is something SLCA has attempted to conduct with its operations.
Factors Affecting Threat from Potential New Entrants
Barriers to entry in the sand and gravel mining industry are high, making it difficult for new competitors to enter the industry. High transportation costs limit a single quarry's distribution area. The largest companies, such as SLCA, hold a dominant position in most regional markets (Source- IBIS World 2012). There are also high start-up costs associated with establishing a mine or quarry. Land leases and mining rights are long-term contracts which are difficult to obtain for developing companies. Environmental regulation and local government zoning laws restrict the development of new mines and raise the value of existing mines. The approval process for a new company take can range from 1 to 3 years (Source- U.S. Silica Investor Relations Report, 2012). Due these high barriers to entry the threat of potential new entrants into the sand and gravel mining industry is weak.
Factors Affecting Threat from Firms Offering Substitute Products
The use of substitute products for glass in end markets such as construction and automobiles could negatively impact the sand and gravel mining industry. For example, the use of plastic instead of glass could reduce the demand for sand and silica. Another potential threat that indirectly affects companies providing frac sand is the development of alternative technologies in the fracking process that use other materials instead (source 10-K). This threat of future substitute products is considered weak because hydraulic fracking is currently very efficient and there are no indications that other processes are being developed that will replace it over the next few years. Overall the threat from firms offering substitute products is currently weak, but it is important to recognize the potential for new threats to develop in this market in the long term.
Factors Affecting Bargaining Power of Suppliers
Because U.S. Silica and its competitors mine raw materials, the majority of suppliers are equipment manufacturers. These suppliers have very little bargaining power over companies in the sand and gravel mining industry. One area which may present problems for companies in the sand and gravel mining industry is the ownership of the land rights to mine. Many of the larger companies such as U.S. Silica own the majority of its mineral deposits which limits royalty payments. Larger companies also have long-term mineral rights leases for its other sources of raw material. These mining leases are generally long-term contracts so once a company has established a contract for mineral rights it is relatively stable and there is little effect from suppliers going forward. Government and environmental organizations can also play a major role in restricting the acquisition of these new contracts and mineral leases. However, once acquired, the company's sources of raw materials tend to be relatively stable. These factors make bargaining power of suppliers over companies in the sand and gravel mining industry weak to moderate.
Factor Affecting Bargaining Power of Buyers
Most companies in the sand and gravel mining industry sell the majority of products under short-term price agreements at the current market rate. A portion of sales also come from long-term contracts that are competitively bid. The most important buyers for the sand and gravel mining industry are fracking, auto, construction and the chemical industry. Because transportation capabilities are such an important factor for buyers, particularly in oil and gas fracking, they are limited in choices when choosing a supplier. Buyers are restricted to either the smaller local competitors or the few large companies within the sand a gravel mining industry who account for 72% of total industry revenue. These factors make bargaining power of buyers a moderate position.
Competitive Advantages of U.S. Silica in the Sand and Gravel Mining Industry
Being one of the largest companies in the industry, U.S. Silica benefits from a well-developed supply network. Its advanced transportation network gives it a logistical advantage over its competitors. U.S. Silica has transloads which are rail stations within the bin all basins of fracking sites. The transloads cut costs for U.S. Silica, passing costs onto the customer while also making the transportation process more efficient (Source- Company 10Q). U.S. Silcia is also looking to expand and utilize more transloads in the future. It also has processing plants located on mine sites and near key transportation stations which allows it to keep costs low. These advantages are difficult for competitors to replicate (U.S. Silica Investor Day Presentation 2013) U.S. Silica also has long-term contracts with businesses and long-term mining leases or ownership of quarries which provides a large obstacle for smaller, developing competitors. U.S. Silica also uses a unique resin coating for its frac sand which makes the sand more efficient and increases productivity of fracking.
The driving forces in the sand and gravel mining industry are demand for sand and silica which is forecast to increase as the U.S. economy recovers and continues to grow. Growth in oil and gas industry will also be a key driver for demand for frac sand. Freedonia predicts industrial Silica to grow at compound annual growth rate (OTCPK:CAGR) of 6% (Source: 10K 2012). This growth will be driven by hydraulic fracturing, flat and other glass (non-container) and building products markets according to a U.S. Silica's 10K report, dated October 2012. Another potentially negative force which will be influential in the industry is new environmental regulations which may possibly restrict the growth of fracking and thus reduce the demand for frac sand.
Key Success Factors
Key success factors for a company in the sand and gravel mining industry are the ability to expand its oil and gas proponent production, increase its presence in industrial and specialty products, and expand its operations geographically. This may be through an expansion of its supply network to ensure its product can reach its customers most efficiently. Another key success factor would be the ability to increase production by expanding its reserve base domestically and internationally as oil and natural gas drilling expands globally. It will also be very important for a company to be proactive in implementing environmentally friendly operations to help reduce the threat of harsh regulations due to the controversial nature of the fracking.
The majority U.S. Silica's closest competitors are privately-owned companies. Financial reports were not readily available for the private companies. Two smaller competitors, High Crush and Carbo Ceramics , are publicly traded and will be compared with U.S. Silica.
Price Trends/Technical Analysis
Figure 7 shows how SLCA has outperformed the stock its competitors and the Russell 2000 Small Cap Index over the last 2 years. Since the beginning of October, SLCA and HCLP have seen rapid appreciation in price.
Figure 8- Percentage Price Change in SLCA vs Russell 2000 and Competitors
From a technical analysis standpoint, Figure 9 shows how SLCA has developed a strong multiyear uptrend after bottoming in July 2012. The stock spent 6 months consolidating between $20 and $24 from March 2013 until September 2013. After breaking above multi-month resistance at $24, which was the ideal entry point the stock has seen a rapid increase which has signaled the continuation of its multiyear uptrend. This uptrend should remain intact over the coming months unless U.S. Silica was to trade below approximately $24-$25 for an extended period of time.
Figure 9- Weekly Candlestick Price Chart of SLCA since IPO in February 2012
Silica Holding Company's and Carbo Ceramics' revenue growth trends are similar. SLCA has experienced an average growth of 27 percent but experienced a large spike in revenue growth from 2011 to 2012 (76%). The growth of all three of these companies can be explained by an increase in demand in the oil & proppant sector. Carbo Cerarmics has experienced growth in revenue after a slight decline (12%) from 2009 to 2011. From 2011 to 2012 CRR experienced a 39% increase. Hi-Crush since its inception in 2009 has increased its revenue by 129% in one year.
Figure: 10 Revenue Growth (2009-2012)- Source Morningstar
*HCLP was formed in October 2010
U.S. Silica Holdings has experienced a positive trend in earnings. From 2009 to 2012 SLCA has experienced an increase of earnings by $73 million. These earnings can be explained by an increase in the oil and proppant sector. Carbo Ceramics had an upward trend from 2009-2011 but has experienced a $24 million decrease from 2011 to 2012. Hi- Crush reported earnings of $9 (MIL) in 2011 and increased their earnings by 34 in 2012.
Figure 11: Earnings Growth (2009-2012)- Source Morningstar
*HCLP was formed in October 2010
PEG (5 yr. expected)
SLCA has the second lowest P/E ratio of 21.13 compared to its competitors where HCLP is the lowest with a P/E of 17.37 and a PEG ratio of 0.77. This suggests that the market may still be discounting future earnings growth and the stock may still be undervalued. The forward P/E for all three companies are lower than the current P/E. This suggests that the market may be discounting all three companies' future earnings. In addition, the D/E of U.S. Silica Holdings has been decreasing over the past few years and we believe that it is contributed to the fact that it has been issuing more stock.
*Beta was calculated using daily closing prices instead of monthly due to lack of data since IPO in 2012
Profit margins for U.S. Silica Holdings increased significantly from 0.62% for 18% from 2010 to 2012. This can be attributed to a larger focus in the oil and gas fracking industry. Profit margin has remained relatively stable since then in a range from 15-19%. Highcrush has the highest profit margin at 34.56% however it has seen a large decrease in profit margin from 57% to 34% during 2013. Carbo Ceramics has seen a large decrease in profit margin since 2009 and currently has a similar profit margin to U.S. Silica Holdings at approximately 15%.
Figure 12-Profit Margin: Source: Y-Charts
Operating Cash Flow
Each of the three companies has experienced significant increases in operating cash flow from 2009 to 2012. U.S. Silica Holdings has experienced the largest increase over the time period analyzed, with an increase of 721% since its base year. Carbo Ceramics is a close second with an increase of 709%. HCLP began recording its cash flow in 2011 and has experienced a jump from 0 to 19 in one year. It was excluded from analysis from 2009 because of a lack of data.
Figure 13-Operating Cash Flow: Source: Morningstar
Return on Equity and Return on Assets
Through 3rd Quarter 2013
Return on Equity (TTM)
Return on Assets
Figure 14-Management Performance Ratios: Source: Morningstar
Two key management ratios that provide valuable insight into the efficiency of SLCA's management team are ROE and ROA. HCLP has the highest ROE and ROA out of the 3 companies. SLCA's ROE of 30.65% is above CRR and a ROA of 10.43%, which suggests that management is using its assets effectively. While HCLP does have a high ROE and ROA it may be benefiting from being such a small company and young (market cap of 926.28 million) which would allow it to record some impressive returns that may not be sustainable.
Current Dividend and Dividend Yield
SLCA pays a modest dividend of 1.50% which is not a sole reason for investing with the company but could provide substantial additional returns if the investment was held for a long period of time. Additionally, HCLP has a dividend yield of 6.00%. However, since HCLP's dividend is higher than its earnings per share, we do not believe that this is sustainable in the long run.
Dividend per Share
Figure 15-Dividends - Source Morningstar
Although SLCA has exceeded the ideal entry price, it is still recommended as a buy. U.S. Silica holdings has strong fundamental numbers such as a solid P/E ratio and low forward P/E, a high ROE, an increasing earnings trend over the last four years, and an estimated increase in future earnings. It is also positioned in growing sand and mining industry that is currently benefiting from an explosion the oil and gas fracking. This growth is predicted to continue to increase in the coming years. It is one of the largest providers of frac sand to the oil and gas industry and has many competitive advantages over its smaller competitors that struggle with high barriers to growth and high transportation costs.
While High Crush pays a higher dividend at 6% and has a higher ROE and ROA, U.S. Silica is almost twice the size with a market cap of 1.79 billion compared to High Crush with 926.28 million. It is also more diversified than High Crush with 38% of its sales coming from the industrial sector. High Crush only supplies to the fracking industry. If there were to be any major problems within the oil and gas fracking industry U.S. Silica would be better prepared than most of its competitors to shift more of their operations back towards the industrial industry, where it has been operating to for over 100 years.
It has also recently completed a strong technical setup that suggests that other market participants are also seeing the growth potential that this stock offers. An ideal entry price would be somewhere closer to the breakout point of $24 as long as the longer term uptrend remains intact. However, it is entirely possible that a stock that has seen such rapid appreciation is just beginning a major long-term uptrend and may not trade down to these prices for some time. Even at its current price of approximately $33, we recommend U.S. Silica as a buy.
For U.S. Silica holdings to remain a buy it would need to maintain its longer term uptrend broken and stay above $20 per share which is a price it has supported and repeatedly been bought from over the previous 6 months. If it were to trade below this point it would suggest that the market no longer agrees with the investment thesis. If this were to happen it would likely be accompanied by a change in fundamentals such as a decrease in earnings, negative regulations that could restrict growth in the sand and mining industry, a decrease in economic growth, and sharp decline in oil and natural gas prices. Even without a price decline it will be important to monitor new long-term leasing contracts and environmental regulations that may be imposed on U.S. Silica holdings. If any of these scenarios appear to significantly impact future earnings then it would be prudent to sell the position regardless of the price of the stock.
Hi Crush Partners 10K. (2012). Retrieved November 2013
U.S Silica Holdings. (2012, March 20). Retrieved November 2013, from MorningStar: quicktake.morningstar.com/stocknet/secdo...?symbol=slca
CRR. (2013). Retrieved 2013, from Morningstar: quotes.morningstar.com/stock/crr/s?t=CRR
FRED. (2013). Retrieved 2013, from research.stlouisfed.org/fred2/
Free Stock Charts. (2013). Retrieved from freestockcharts.com
HCLP. (2013). Retrieved 2013, from Morningstar: quotes.morningstar.com/stock/hclp/s?t=HCLP
SLCA. (2013). Retrieved 2013, from Morningstar: quotes.morningstar.com/stock/slca/s?t=SLCA
Yahoo Finance- CRR. (2013). Retrieved 2013, from Yahoo Finance: finance.yahoo.com/q?s=CRR
Yahoo Finance- HCLP. (2013). Retrieved 2013, from Yahoo Finance: finance.yahoo.com/q?s=HCLP
Yahoo Finance-SLCA. (2013). Retrieved 2013, from Yahoo: finance.yahoo.com/q?s=SLCA
Y-Charts. (2013). Retrieved 2013, from y-charts.com
King, H. (2013). What is Frac Sand? Retrieved 2013, from Geology: geology.com/articles/frac-sand/
Kruchkin, A. (2013, March). Sand and Gravel Mining in the U.S. Retrieved 2013, from lgdata.s3-website-us-east-1.amazonaws.co....pdf
Silica, U. (2013). Energy Conference 2013- Investor Relations.
Numbers in Thousands
SLCA - INCOME STATEMENT
Cost of Revenue
Selling General and Administrative
Total Operating Expenses
Operating Income or Loss
Income from Continuing Operations
Total Other Income/Expenses Net
Earnings Before Interest And Taxes
Income Before Tax
Income Tax Expense
Net Income From Continuing Ops
Effect Of Accounting Changes
Preferred Stock And Other Adjustments
Net Income Applicable To Common Shares
SLCA - BALANCE SHEET
Cash And Cash Equivalents
Other Current Assets
Total Current Assets
Property Plant and Equipment
Deferred Long-term Asset Charges
Short/Current Long-term Debt
Other Current Liabilities
Total Current Liabilities
Deferred Long-term Liability Charges
Misc Stocks Options Warrants
Redeemable Preferred Stock
Other Stockholder Equity
Total Stockholder Equity
Net Tangible Assets
SLCA - CASH FLOW
Operating Activities, Cash Flows Provided By or Used In
Adjustments To Net Income
Changes In Accounts Receivables
Changes In Liabilities
Changes In Inventories
Changes In Other Operating Activities
Total Cash Flow From Operating Activities
Investing Activities, Cash Flows Provided By or Used In
Other Cash flows from Investing Activities
Total Cash Flows From Investing Activities
Financing Activities, Cash Flows Provided By or Used In
Sale Purchase of Stock
Other Cash Flows from Financing Activities
Total Cash Flows From Financing Activities
Effect Of Exchange Rate Changes
Change In Cash and Cash Equivalents