U.S. Silica (NYSE:SLCA) reported revenues of $423.2 million in the third quarter, which was down 1% from the previous quarter due to widely-reported delays in completions that caused pricing to momentarily suffer. So call the coroner, they must be going bankrupt.
SLCA even made net income, added new last mile offerings, and increased Oil & Gas volumes 10%, which proves that the business is not in trouble. As long as this does not turn into a trend of weaker quarters (SLCA said the recovery is expected to happen in the next two quarters), then this bushwhacking will turn out to be false, and prove that the stock was a buy all along.
U.S. Silica's Industrial & Specialty Products segment continues to impress, and Wall Street repeatedly ignores it. More records were broken for contribution margin per ton, which increased 103% year-over-year. SLCA's ISP business grew revenues by $120 million, and saw the full effects of their acquisition of EP minerals completed last May. They also have over 100 projects waiting to be completed. So, this is providing much needed diversification to Oil & Gas revenues, and points to another catalyst ahead for SLCA.
SLCA is showing that it can execute in a tough environment, and that it has the diversification needed to survive a downturn. However, the stock, much like other frac sand players, is given no credit for its success.
I believe shares are still a buy long term, since in-basin pricing will remain strong, where 70% of SLCA’s revenues are based.
There are various dynamics driving a more bullish picture for frac sand than even I previously expected, which was $65-$75 long term. In-basin numbers are around the $60s or $70s anyway, according to SLCA. So if pricing can hold up that well for SLCA during a slowdown, then imagine what the spot numbers could look like when completions resume in the next two quarters.
There are other factors, though, that are making me more bullish on long-term pricing. The first being pushback on brown sand, which is happening sooner than I thought. From the Q3 earnings call:
First, local sand capacity continues to come online with most of the capacity additions in the Permian so far. We are also seeing local sand projects in other basins with varying degrees of market acceptance. We believe that as much as 12 million to 14 million tons of new capacity could eventually come online outside the Permian mostly in South Texas and the MidCon. We do however expect that many of our customers will continue to want to pump Northern White Sand in these basins, as well as other geographies such as the Bakken, the Rockies and the Northeast.
Secondly, more tons are expected to be idled from higher-cost mines. 12 million tons have already been idled by the industry, and now another 10 million to 15 million tons of "non-local" supply is expected to come off in the coming quarters if need be. This would bring pricing into equilibrium faster than expected by even me, the most optimistic of investors. Again from the Q3 earnings call:
That said, incremental local capacity will pressure Northern White sales volumes and margins and we experience that in Q3. As more local mines come online, we expect that higher cost Northern White mines will be closed and we have already seen more than 12 million tons per year of idle capacity. We believe that another 10 million to 15 million-ton of non-local capacity may come off line in the next few quarters.
In-basin pricing will stay strong due to sand being too bulky to transport out-of-basin with trucks beyond 300 miles, which also forces higher-cost NW to exit the supply and demand equation.
This is the key to SLCA's earnings in the coming quarters, as 70% of their current capacity is in-basin. Northern White mines of theirs should continue to find a home in all-basins, including the Permian, since they are the lowest cost NW provider. This means they can still rail NW into basins, while others higher on the cost curve cannot. Again, those will probably be the ones to idle their tons.
Permian volumes are tripling by the end of 1Q 2019, so SLCA will be even less dependent on NW sales then anyway. If too much brown comes online in the Permian, the lowest-cost providers of brown like SLCA will force higher-cost miners to idle their volumes, too. Silica and the big four public frac sand companies like Emerge Energy (EMES), Covia (CVIA), Hi-Crush (HCLP), and U.S. Silica will always win.
SLCA is forecasting 110 million tons of industry demand in 2018 increasing to 130 million tons in 2019, where 150 million to 155 million tons of effective capacity in 2019 are expected to come online. This means that if 15 million more tons are idled and completions resume, then we should be sold out at strong pricing, which would be back in the upper $70s to $90s again.
U.S. Silica had a solid quarter despite transitory slowdowns in completions placing downward pressure on pricing. Every segment of their business has catalysts to look forward to. New industry themes, which are moving towards self sourcing sand in-basin while securing a last-mile option, is also working in SLCA's favor since that's where 70% of their capacity is located. They also have the best last-mile offering in the business, which further incentivizes pressure pumpers to go with SLCA and the Big 4 over traditional services players like Halliburton (HAL).
However, none of these positives matter in the short-term, as the frac sand industry is being priced for bankruptcy. The fears are due to weak pricing and in-basin mines popping up (which are most likely higher-cost) that everyone seems to think can be sustained. For reasons I have laid out previously with WildHorse Resource Development (WRD), which is an example of an E&P building their own sand mine, this cannot be sustained on a large scale.
These empty, bearish claims on frac sand are plaguing U.S. Silica's share price. But if pricing remains bullish like I expect, then earnings should continue to increase. Therefore, I see no reason to abandon the stock now, and will stay long shares.
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Disclosure: I am/we are long SLCA. 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.