Smart Sand (NASDAQ:SND) is a misunderstood company in a depressed sector. This relatively new proppant technology in the oil industry's second life has recently been plagued by over-expansion and massive debt loads. Smart Sand is relatively new as it just IPO'd in 2016 and was only founded in 2012. This company is not like proppant incumbents and does things a little differently. Because of key differences to its peers Smart Sand has quickly become the largest holding in my portfolio and even now I'm still adding as many shares as I can get my hands on.
If you have read any of my previous articles you will notice I'm generally attracted to undervalued companies on a price to book value basis. This company is no exception as it currently stands at half of its book value. What is interesting about this company is its severe undervaluation when it has not had a negative year since its IPO. Yet this has not stopped fears of the industry being saturated and dragging the stock down from its highs of over $15 a share!
Smart Sand is currently hovering at around $2.50 per share, if it were to reach the highs it was once at that would be an over 600% increase! If you're only going to stick around for its return to book value then you're looking at about 100% increase, which is quite a substantial return on your money and in my opinion almost certain.
The company's management pay structure is a bit different than other CEOs in the industry. According to salary.com Charles E. Young the CEO of Smart Sand made $512,308 with a bonus of $140,884. Accounting for his total pay including stocks and options that number comes to $1,668,182. Comparatively the CEO of Hi-Crush Robert Rasmus made $2,308,369 and U.S. Silica CEO Bryan A. Shinn made $4,158,772. While U.S. Silica is about 9 times larger than Smart Sand it still comes as a shock that U.S. Silica, a company losing money and shareholder value, has a CEO collecting over half a million in bonuses. It's actually quite infuriating just think of the lost potential company value from the inefficient and negligent bonus structure.
The share ownership breakdown between the three companies paints an even more interesting story. Robert Rasmus owns 48,189 out of 101 million shares of Hi-Crush and Bryan A. Shinn owns 323,514 out of 73 million shares of U.S. Silica. While Charles E. Young owns 267,401 out of 40 million shares of Smart Sand. Taking a look at these share ownership totals we can see that CEO Charles E. Young has a higher stake in his own company than any of the above mentioned CEO's have in their companies. As a shareholder this is very reassuring and hopefully as the company expands the CEO's base and bonus won't become absurd like the others in the industry.
(note: These share ownership totals were taken from Wallmine and match alternate sources)
Smart Sand is leading the industry with its true to its word take or pay contract structure. I say true to its word, because Hi-Crush mentioned having a similar structure but has fairly recently failed to carry through on some customers. According to Morningstar's equity analyst report, Smart Sands contracts generally last around two years. This is in stark contrast to much of the industry's reliance on the spot market or non-contractual sales of proppant or sand. It's a bit reminiscent of how Southwest Airlines benefited with its fuel contracts while the industry as a whole suffered with high jet fuel prices.
The reliance on two year contracts allows Smart Sand a much greater flexibility with its infrastructure build-out. If they know how much they have coming in over a period of time it is much easier to realistically evaluate and expand operations. It's apparent that this tactic is being utilized as last quarter seemed to be the first quarter of reduced expansion. You can see the slight increase in net cash through analysis of the cash flow statement.
While this may look terrible to a growth investor Smart Sand has the lowest debt to equity ratio in the industry, coming in at just below 25%. This is a huge reassurance to a value investor as anything above 25% starts to become unpalatable and anything above 50% is horrifying. In the future I would like to see Smart Sand begin to utilize nothing but cash flow to build out its operations unless a nice uptick in oil prices makes investment too good to pass up.
Smart Sand has a nice runway for growth and positioned itself as the highest quality sand in the industry through focused build-out of its Oakdale location. Oakdale is conveniently serviced by competing Union Pacific and Canadian Pacific rail lines whilst producing high quality sand. Management has pointed out as Smart Sand grows it will be able to negotiate competitive transportation rates.
Transportation rates are a big deal. Smart Sand breaks down its revenue sources on its 10-K and 25% comes from transportation. If they can leverage their transportation rates with the railroads, this can either increase their transportation percentage or build in greater flexibility on future contracts that other proppant suppliers cannot match. This transportation competition and heavy reliance on rail over trucks could push the company to have an even better COGS (cost of goods sold). Smart Sand is already competitive and a low cost leader and any further cost savings will only push it to be even more profitable.
Smart Sand's market undervaluation can partially be explained by growth fears. An oversaturation of sand supply has caused many to believe that northern white sand cannot compete in the Permian Basin in Texas. However, the problem with most sector analysts is they fail to dig in deeper on individual company operations. Smart Sand obtains a significant portion of their profit from the Bakken Formation in North Dakota.
The acquisition of Quickthree Solutions and the Van Hook terminal further cemented their presence in North Dakota. While the Quickthree Solutions purchase is hard to measure value, it could possibly result in a decrease of healthcare payouts in the future. Problems arise in the lungs when silica dust is breathed in continually. While hard to measure it is most certainly beneficial and valuable to future operations. The Van Hook purchase does provide an immediate value in transportation cost reduction as it allows one of the closest and cheapest methods of transport by train.
If you follow seeking alpha news in the proppant space, you may have begun to see an interesting shift. Northern white sand just seems to be better. It has a much better recovery rate than the sand producers in the Permian Basin. U.S. Silica even went so far as to say that they have seen a shift in purchases from their local sand production to their northern white production, on their conference call.
This could prove to be an epic windfall if northern white demand increases, leading to higher prices and possibly a move by Smart Sand to cash in on the Permian market.
Smart Sand can even ramp up its production by utilizing its undeveloped Hixton site. This site according to Morningstar "shares many of the advantageous characteristics of the company's flagship Oakdale location."
Smart Sand shares many of the risks of the overall industry. Fears of low prices of oil and the march towards sustainable energy are among a few. However many of these fears and macroeconomic concerns are a far cry from reality. The world is still using more oil every year than the previous, and sustainable energy is still just too expensive to be a real threat.
Smart Sand does have a micro threat that may prove to be an issue. It has taken Schlumberger (SLB) to court because of failure to honor their contract and pay over a million in estimated charges. While not a large part of Smart Sand's overall revenue it may result in a more existential threat if other companies think they can somehow get out of their contracted rates.
At current levels Smart Sand is an overwhelming buy. Its favorable contract structure, aligned management, and growth runway all lend themselves to a favorable future for Smart Sand. The positives outweigh the negatives as the company has the ability to more than double in price at the first sign of recovery in the oil and gas supplier space. I am currently buying at $2.50 levels and anticipating selling around $9 per share unless the book price shoots up considerably or a dividend is announced.
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Disclosure: I am/we are long SND. 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.