A sharp reduction in new oil and gas drilling activity -- and the rapid implementation of new technologies in the field -- has not been kind to the providers of downstream services. Road builders, water transporters, pipe manufacturers, and frack sand producers have all been sacked by the shale industry's relentless pursuit of lower production costs. While a sharp stock recovery in 2016 may have reset the short-term memories of investors,U.S. Silica Holdings (NYSE: SLCA) found itself caught in the worst of the crossfire.
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With that in mind, you may find it surprising that the company managed to grow its cash balance from just $298 million at the end of 2015 to over $660 million at the end of the first quarter of 2017. That's even more surprising after considering that the company pulled the trigger on several acquisitions that gobbled up at least $212 million in cash. How the heck did it do that and, more importantly, is it sustainable?
Image source: Getty Images.
What's going on here?
The answer is pretty simple: U.S. Silica Holdings boosted its cash position through stock offerings. The first, in March 2016, provided gross proceeds of $174 million. The second, in November 2016, injected gross proceeds of $416 million with only slightly more shares involved thanks to a much higher stock price at the end of the year. The offerings played a significant role in pushing the number of shares outstanding from 53 million at the end of 2015 to 81 million at the end of 2016.
It was all part of a very aggressive strategic plan by management to double down on long-term growth opportunities, even when others in the industry were questioning their very ability to survive. Industry consolidation during down cycles is nothing new, but U.S. Silica wasn't waiting around for other companies to claim the market's leading position.
So far, Wall Street has rewarded management for its aggressiveness.
Of course, the company cannot issue shares for operating capital in perpetuity. But while that isn't sustainable, the business created by recent acquisitions could prove valuable in the long run. Assuming frack sand consumption returns to previous levels, U.S. Silica Holdings may be the best-positioned proppant manufacturer in the industry.
Consider that recent acquisitions have included:
- Proppant logistics and transportation firm Sandbox Enterprises for a total of $218 million in cash and stock.
- Texas-based proppant producer NBR Sand for an undisclosed amount. Giving U.S. Silica Holdings over 2 million tons of annual capacity near the fast-growing Permian Basin.
- A fully permitted 327-acre parcel of land in Illinois with 30 million tons of proven reserves of Ottawa White sand, which also can also be applied to industrial applications outside of the oil and gas industry.
- A division of National Coatings Corp. that manufactures industrial roofing systems that boost a building's energy efficiency by reflecting solar rays back into the upper atmosphere.
These newly acquired assets have the potential to contribute to operating cash flow and earnings for years to come. While management is apparently doubling down on a rebound for its oil and gas proppants segment, which provides most revenue and earnings, growth in the higher-margin industrial and specialty products segment is important for diversifying the top line.
The value of this diversification was evident in the first quarter of 2017:
Data source: U.S. Silica Holdings.
The industrial segment will become even more important in the long run, especially if new drilling activity wanes or new technologies that allow for lower volumes of frack sand per well are widely adopted.
Long story short
The good news for investors is that the demand for proppants has steadily risen since the third quarter of 2016. That should allow U.S. Silica Holdings to begin reaping the rewards of its aggressive long-term growth strategy and alleviate any concerns of runaway dilution. Even better, it should enable the return of healthy operating cash flow, which settled in at just $380,000 last year after achieving $171 million in 2014. Plus, with a near-record cash balance at the beginning of the recovery right now, things could get more interesting still.
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