Image Source: U.S. Silica corporate website.
Any company whose fate is tied to the spending of oil and gas has had a rough year, and U.S Silica is no different. However, its non-oil and gas-related sand products helped to prop up its earnings this past quarter .
But like so many other commodities, frack sand is a cyclical product that's in the middle of a rough downturn, and this isn't the first time the company has dealt with industry cycles. In fact, despite the current market conditions, U.S. Silica's management thinks there are a few things investors should look forward to. Here are five key takeaways that U.S. Silica's management mentioned in its most recent conference call of which investors should take note.
The industry downturn isn't as bad as some think
Over the past year, we've pretty much watched oil and gas activity evaporate in the United States. The Baker Hughes rotary rig count declined 61% as companies scaled back their spending. The immediate reaction to that sort of decline is to assume that sand suppliers such as U.S. Silica would experience a similar level of pain. According to CEO Bryan Shinn, though, the company has been able to do much better than the rig counts suggest:
In oil and gas, our sales volumes in the third quarter were just 19% lower than the peak run rate that he saw in the fourth quarter of 2014. Since that time, U.S. rig count declined approximately 55%. I believe that the strength of our sales volume in Q3 demonstrates a few key points. First, our customers are continuing to pump more sand per well and per rig. A recent industry report estimated that sand consumption per horizontal well increased 26% from the third quarter of 2014 to the second quarter of 2015. Second, our sales growth rate this quarter clearly shows that U.S. Silica is taking significant market share. And third, we're seeing a flight to quality as customers are increasingly choosing U.S. Silica as one of their top suppliers. Those are all certainly positive trends for our company.
The important note here is that U.S. Silica is taking market share from its peers. Things such as sand consumed per well and overall activity are out of the company's control, but if it can make an offer that others in the space can't, then that should bode well for the future.
We're cutting operational costs
The market for frack sand is pretty fragmented, which means suppliers such as U.S. Silica are price takers, and the one thing it can do to control its destiny is to control costs. Luckily for investors, U.S. Silica has done a respectable job in lowering costs not just this quarter, but so far this year. From Shinn:
We have continued to reduce staffing and improve productivity. Year to date, we reduced headcount at existing facilities by approximately 10%, and tons produced per labor hour are at an all-time high. We have also negotiated price concessions from many suppliers, optimized plant maintenance expenditures, and reduced railcar demurrage expenses. All in, our various cost improvement initiatives yielded more than $1.50 per ton in savings during the quarter, the majority of which should be sustainable going forward. We're also on track to exceed our stated goal of a 20% SG&A reduction versus plan.
Another Aspect that Shinn noted was that some of its facilities aren't running at optimum capacity, so when drilling activity picks up and sand demand increases, per-unit costs could be even lower than where they are today.
The outlook is still rough
A rebound in oil and gas demand will come, and it will bring with it increased activity. However, just as so many other management teams have said recently, U.S. Silica isn't counting down the days. Rather, it's bracing for this downturn to stick around for a while. Again from Shinn:
We're preparing for a potential steep drop in product demand in December based on a combination of factors, including the normal seasonal slowdown, concerns that some energy companies have already exhausted their 2015 capital budgets and service companies talking about sending crews home starting as early as Thanksgiving. We anticipate that these factors will pressure volumes and pricing in our Oil and Gas business through the end of the year and possibly into the first quarter of 2016. Lower volumes will not only decrease revenue but reduce our fixed cost leverage as well, putting additional pressure on margins. ISP is expected to have a solid fourth quarter for many of the same reasons the segment was so successful in the third quarter, although volumes are expected to be lower given the seasonal nature of that business.
Could we become an industry consolidator?
Yes, frack sand is a pretty fragmented industry, but this downturn seems to be pushing a lot of companies to the brink. In fact, the CEO of frack-sand peer Hi-Crush Partners mentioned on its conference call that it thinks as many as 15 sand mines have closed as some of the smaller players get weeded out. U.S. Silica's management sees this as an opportunity to capture even greater market share by perhaps acquiring a mine or two from some distressed players. This is what Shinn had to say:
I think not a lot has changed in terms of the market rationale for that. We still have a very fragmented supply base today for frack sand, and we continue to believe that consolidation is inevitable. And so I think the opportunity that we saw to leverage our scale and resources to service customers better are certainly all there. And so we're working hard to drive that across the industry, and I feel like as we get into more challenging environments here, it's likely to help close the bid-ask.
Pricing may not react as quickly as demand
More than anything, U.S. Silica and its peers would like to see some price relief. Smaller players that get knocked out of the market could clear some room in the market, but one thing to consider is that there's a lot of spare or idle capacity out there right now. According to Shinn:
Our view of that capacity that's come offline is 12 million to 13 million tons, somewhere in that range. I think at the same time, we have a number of sites that are running at reduced capacity, so that adds further to the mix. So there's a fair amount of capacity that is offline right now. And I think when you add all that up, the numbers are probably somewhere between 20% to 30% of the industry capacity is completely offline right now.
This is an important point, because once activity starts to pick up, a decent portion of that idled production capacity might get ramped up before we see a large increase in prices. So it's entirely possible that we'll need to see a large demand response before we see the effects in U.S. Silica's bottom line.
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The article The Key Components of the Frack-Sand Market U.S. Silica's Management Wants You to Know originally appeared on Fool.com.
Tyler Crowe has no position in any stocks mentioned. You can follow him at Fool.com or on Twitter @TylerCroweFool .The Motley Fool recommends U.S. Silica Holdings. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .
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