Frac Sand Companies (SLCA)

[dan_s]

Below are notes from Stifel. For those of you that own Hi-Crush, note that profit margins on the "last-mile" business is much better than the profit margins on raw sand sales.

In its presentation yesterday at Stifel's CSI Conference, U.S. Silica (SLCA) reiterated its expectation that 75% of 2019 profit will be generated by its Sandbox last-mile logistics solution and its Industrial & Specialty Products (ISP) segment. Assuming frac sand price remains stable and SLCA continues to growth its logistics and ISP business, oil & gas proppants will likely continue to represent a smaller percentage of SLCA's profits. We believe this could lead to a revaluation of the shares over time.

Key Points
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ISP Growth Likely Continues: The company's ISP segment has posted a 22% CAGR over the last five years and appears well positioned
to continue to generate strong growth over the next several years. The growth is fueled by both GDP-like growth in a few areas as well as
several new product introductions, which in aggregate should drive 10%+ annual growth. In meetings yesterday, management noted that
the ISP business tends to be very sticky due to the location and geology of its mines, high barriers to entry, the fact its sand is specified into
customer's manufacturing operations, and its long-term contracts (which generally range from 2-5 years with price escalations each year).
•
Sandbox: Sandbox currently has approximately 25% market share with over 90 units in the field. Sandbox has over 60 patents which range
from physical construction of the box to the process of filling each box and even the delivery of a filled box to the well site. Management
believes Sandbox will account for slightly more than 25% of expected 2019 contribution margin. We expect the company's Sandbox units
to continue to post solid growth over the next several quarters.
•
Frac Sand Possibly Stabilizing Longer Term: Frac sand has clearly faced significant headwinds over the past year as in-basin capacity
surged and pricing for both Northern White Sand (NWS) and in-basin sand weakened. U.S. Silica continues to boast a low-cost structure
with mines close to railroads in Wisconsin as well as in-basin mines well positioned in Texas. Management noted that a long-term
contribution margin could range from $5-10 per ton for frac sand, which would equate to $90-100+ million. We believe U.S. Silica can deliver
close to $10 per ton in contribution margin given its low cost structure at a price level that equates to cash breakeven for many competitors.
•
Returning Value to Shareholders: U.S. Silica is committed to allocating capital in its growth businesses such as ISP and Sandbox or
paying down debt (approximately $1.3 billion as of March 31) while moving away from historic investments in Oil and Gas. Over the last
six quarters, U.S. Silica repurchased $174 million of its own stock, maintained a $0.25 per share annual dividend, financed its recent
acquisitions through cash flows from operations, and expects to be cash accretive in 2019.
•
Key Growth Driver: In its presentation, management noted it expects solid EBITDA growth going forward driven by: 1) Sandbox market
share gains; 2) new horizontal and vertical applications for Sandbox; 3) a pipeline of new, higher margin ISP products that could equate to
$200 million in annual contribution margin over time; 4) regular price increases for the ISP segment; and 5) potential bolt-on acquisitions.
•
Valuation Appears Attractive: U.S. Silica are currently trading at 7.1x and 4.9x our 2019-20 EBITDA forecast of $257 million and $369
million, respectively. Our current target price of $18 represents 71% from current levels and is based on a sum-of-the parts analysis.