Over the last four years, one of the most interesting segments of the economy to pay attention to has been the energy sector. That doesn’t mean following the biggest players in the the oil industry, although there have been some really interesting investing opportunities among those companies over the last couple of years. It also means keeping track of “energy-related” stocks. Like the smart entrepreneurs during the California Gold Rush that sold picks and shovels to prospectors instead of mining for gold themselves, these are companies that provide the services, materials and equipment that energy explorers and producers need to run their own business.
U.S. Silica Holdings, Inc. (SLCA) is one of the Energy Equipment & Services companies that first caught my eye four years ago, and they continue to provide good opportunities to employ a value-oriented approach even as the stock market in general continues to surge and oil prices drive higher. The stock is best known as a sand producer, providing the silica-based materials that fracking companies use to extract oil and natural gas from oil-rich areas throughout the U.S. like the Permian and Eagle Ford Basins, to name just a couple. Over the last couple of years, however, the company has made a concerted effort to expand their portfolio beyond frac sand only. The opportunity comes from the fact that the market seems to have completely discounted many of these efforts, and is instead focusing on short term-focused fundamental measurements that don’t account for the measures the company is consciously and purposefully employing to position itself for the years ahead.
Here’s an example: currently, the company operates with two primary segments: Oil & Gas, and Industrials, with 70% of their business coming from Oil & Gas and 30% from Industrials. The company has been investing heavily (to the tune of about $500 million over the last couple of years) to expand its ability to deliver silica products to both segments, with the goal of shifting the mix between the two segments over the next few years to 40% Oil & Gas/60% Industrials.
Their investments include a heavy investment in the Permian Basin, where infrastructure hasn’t been able to keep up with production demand for the last several months. That has depressed energy prices coming from that region and put a cap on the number of completed wells that are actually in production. Much of that infrastructure is expected to start coming online in 2019 and 2020, and as it does, the more than 8,000 currently idle wells represent a massive backlog that producers can tap into to keep up with increased capacity. That is likely to keep demand for frac sand very high as soon as next year and to remain high for the foreseeable future.
Earlier this year, SLCA also completed the acquisition of EP MInerals, a business that works with non-silica products like clay, diatomaceous earth and perlite. These are products that are used in a variety of non-energy-related industries; diatomaceous earth, for example, is used in the food and beverage industries as a filtration material. EP Minerals is a dominant player in this particular segment, and the acquisition gives SLCA an attractive way to diversify and expand their business in the long-term, with industrial sand applications that offer high profit margins with far less cyclicality than the company has historically learned to work with by focusing almost exclusively on the Oil & Gas portion of their business.
The company’s fundamental measurements are interesting, as I’ll show you next; but the real story here is just what kind of value opportunity I think there is with this stock right now.
Fundamental and Value Profile
U.S. Silica Holdings, Inc. is a domestic producer of commercial silica, a specialized mineral that is an input into a range of end markets. The Company operates in two segments: Oil & Gas Proppants, and Industrial & Specialty Products. In the Oil & Gas Proppants segment, it serves the oil and gas recovery market providing fracturing sand, or frac sand, which is pumped down oil and natural gas wells to prop open rock fissures and manage the flow rate of natural gas and oil from the wells. As of December 31, 2016, the Industrial & Specialty Products segment consisted of over 215 products and materials, which are used in a range of industries, including container glass, fiberglass, specialty glass, flat glass, building products, fillers and extenders, foundry products, chemicals, recreation products and filtration products. It produces and sells a range of commercial silica products, including whole grain and ground products, as well as other industrial mineral products. SLCA has a current market cap of about $1.5 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings grew more than 68%, while Revenues grew a little over 47%. Growing earnings faster than sales is hard to do, and generally isn’t sustainable in the long term; however it is also a positive mark of management’s ability to maximize a company’s business operations. In the last quarter, earnings grew about 18.5%, while sales grew almost 16%.
- Free Cash Flow: SLCA’s free cash flow has been negative since early 2016, which is a reflection of the company’s capital investments as I previously outlined. In their last earnings report, management indicated those expenditures were largely complete, with the company now shifting its focus to maximizing revenues and cash flows from the assets they have acquired or put into place.
- Dividend: SLCA pays an annual dividend of $.25 per share, which translate to an annual yield of 1.28% at the stock’s current price.
- Return on Equity/Return on Assets: These numbers are healthy. ROE is 13.14 and ROA is 7.06.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for SLCA is $19.44 and translates to a Price/Book ratio of 1.1 at the stock’s current price. The stock’s historical average Price/Book ratio is 1.94, suggesting the stock is incredibly undervalued, by nearly 75%; at par with its average, the stock should be trading at about $34 per share. A drive back to par with that level would put the stock back near to the highs it reached in May of this year, but still below its 52-week highs at nearly $39 per share.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The stock’s 52-week high came in late January of this year, with the stock dropping down to about $23.50 per share at the beginning of April, and then rebounding to about $34 in late May. From that point, the stock has staged a significant downward trend, and has most recently broken below short-term support at around $22. That bearish momentum does put the stock in danger of testing its multi-year lows, when it bottomed in late 2016 at around $13 per share following the collapse in energy prices. If it does find support in the near-term, look for resistance around $23.50 from its April pivot low point. The stock would need to break this level to stage any kind of sustainable bullish momentum that would translate to a legitimate upward trend.
- Near-term Keys: If you like the stock’s value proposition, the stock’s latest decline in price should be seen as an attractive buying opportunity – with the caveat that you don’t discount the possibility that the current downward trend could force the stock into the low teens. If you prefer to work with a shorter-term perspective, the market’s treatment of this stock lately means that the smart move would be to work with bearish strategies like shorting the stock or buying put options. If you want to take a more measured and conservative approach to buying the stock, wait for the stock to show signs of stabilization, with a push above $24 acting as a strong signal to either buy the stock or start working with call options.