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U.S. Silica
Ticker: SLCA
New York Stock Exchange
Industrial Metals & Minerals
Recommendation: Buy
Price 1/30/2014 $32.02
Target Price: $37-$40; 27.91% increase
Business Description
U.S. Silica is a producer of industrial minerals, including whole grain, ground, and fine
ground silica, sand proppants, calcined kaolin, and aplite clay. U.S. Silica’s products are used
in a variety of areas; ranging from fracking to glass production, to water filtration, to molding
and foundry. Products are sold domestically, though highly concentrated in the Eastern
United States. U.S. Silica generates revenue from two business segments: Oil & Gas and
Industrial & Specialty Products. 70% of revenue earned is through the Oil & Gas segment.
Although the Oil & Gas segment is only a portion of U.S. Silica, almost all of the company’s
growth will come from customers in the hydraulic fracturing end market. The remaining 30%
of revenue is earned through the Industrial & Specialty Products segment. The ISP segment
sells to various manufacturing end markets including glass, chemical, construction, paint and
rubber, and others.
Industry Overview
Attractiveness of Natural Gas Fueling Demand
The price of natural gas has decreased 66.62%, from $7.97 in 2008, to $2.66 in 2012. The
recent explosion of hydraulic fracturing in the United States has caused an abundance of
supply leading to this price depreciation. According to the Freedonia Group, hydraulic
fracturing grew at an annualized rate of 27% from 2001 to 2011. This rapid increase in
supply means that demand has not had a chance to catch up yet. However, natural gas prices
have encouraged a revival in manufacturing and the attractive price of natural gas is
increasing demand significantly. In the chemical-manufacturing sector alone, companies are
building plants worth an estimated $95 billion, according to IHS Global Insight. Most power
plants can easily be converted from coal to natural gas, meaning switching costs are very low.
According to Forbes Magazine, “generating electricity by burning natural gas is cheaper than
burning coal if the price of natural gas remains below $3/mmBTU.”. Natural gas’ relatively
cleaning burning properties compared to other fuel sources has also increased its
attractiveness. These factors are expected to lead to surging demand for natural gas, which
should continue to drive growth in hydraulic fracturing industry. Silica is a proppant used
directly in the hydraulic fracturing process, meaning as hydraulic fracturing continues to
grow, the silica industry should see similar levels of growth.
Shipping Prices Affecting Profit
Shipping is a major component of U.S. Silica’s business operations. Because of the size and
weight of loads, the fracking material must be delivered via train to fracking and/or storage
sites. Silica’s low value to weight ratio also makes supply chain efficiency vital to success in
the industry. “While some customers have shipping contracts that lock-in a price for 3-5
years, a majority of shipping is done at the spot, limiting the margin on shipping”. Shipping
costs are expected to increase next year, which will continue to depress margin. U.S. Silica
has also decided not to pass transportation costs fully onto customers to kept price points
competitive in order to gain market share from local competitors.
EPA Still To Rule On Fracking Dangers
Many news outlets are reporting that the Environmental Protection Agency will not rule on
fracking contamination cases in the near future. Prior to this late-December report, the EPA
was researching the link between the contaminated water supply in Park County, Texas and a
nearby fracking site.
Competitive Positioning
Leveraging Efficient Supply Chain and Economies of Scale to Increase Market Share
U.S. Silica’s efficient and expansive supply chain allows it to keep margins high, while
delivering its products to customers quickly and effectively. The company’s size also allows
it to operate economies of scale and reduce transportation costs. Low lead times has made
U.S. Silica attractive to customers and allowed the company to increase its market share
significantly. Silica products are shipped directly to customers by truck, rail, ship or barge,
depending on which option is most cost efficient. This flexibility gives U.S. silica a
significant advantage over its competitors. U.S. Silica’s main competitive advantage comes
from its supply chain efficiencies and capabilities. The company has been able to leverage its
economies of scale and efficient supply chain to keep prices low and increase its market
share, without harming margins significantly.
U.S. Silica's Transportation Capabilities
Investment Summary
Summary of Valuation Approaches
To properly evaluate U.S. Silica market valuation, we compared the firm using discounted
cash flow, dividend discount model, forward P/E, TTM P/E, EV/EBITDA, and PEG ratio.
The majority of the models demonstrated that U.S. Silica is undervalued in the market.
Through the DCF model we determined that the stock’s intrinsic value is almost 30% higher
than the current stock price of $32.
Weightings of Valuation Approaches
How much weight are we giving to each intrinsic value?
To provide a proper valuation, we developed a weighted average of all six methods with the
following weights: Forward P/E 15%, TTM P/E 15%, EV/EBITA 15%, PEG ratio 15%base
case DCF 30%, worst case DCF 10%; using those weights, our projected stock price for U.S.
Silica was $38.00, making U.S. Silica’s stock is currently undervalued by 18.74%.
Valuation Conclusions
We encourage investors to buy due to the growth potential of U.S. Silica. The firm’s growth
in the industry and value-added services will accelerate their future sales. Although investors
may be concerned with EPA investigations of fracking, U.S. Silica’s CEO Bryan Shinn,
reassures the firm is entering the market at the beginning of the shale revolution and will not
be negatively impacted by investigations. Our calculated intrinsic value of U.S. Silica
indicates there is a potential 20% investment upside.
Valuation
U.S. Silica’s Multiples Comparison
Using comparisons on U.S. Silica’s EV/EBITDA and P/E ratio (both trailing twelve months
and forward), we conclude that U.S. Silica’s stock is currently undervalued. The comparison
benchmark is currently comprised of Carbo Ceramics, Inc. (ticker: CRR) and Hi-Crush
Partners LP (ticker: HCLP). Using the benchmark forward P/E and forward earnings of
$2.18, U.S. Silica would trade at $39.79, (24.33% upside). Using the benchmark trailing P/E
and trailing earnings of $1.55, U.S. Silica would trade at $39.01 (21.92% upside). Using the
benchmark EV/EBITDA and earnings of $2.18, U.S. Silica would trade at $35.21 (10.02%
upside). Using the benchmark PEG ratio, trailing earnings of $1.55, and projected EPS
growth of 17.50%, U.S. Silica would trade at $39.33 (22.91% upside).
U.S. Silica’s Investor Value Comparison
Weight
-50%
50%
Forward P/E
Ticker
SLCA
HCLP
CRR
Weighted Average
Weight
-50%
50%
EV/EBITDA
Ticker
SLCA
HCLP
CRR
Weighted Average
Value
14.75
11.10
25.40
Weight
-50%
50%
TTM P/E
Ticker
SLCA
HCLP
CRR
Value
21.46
17.42
32.92
18.25
Weighted Average
25.17
Value
13.77
16.97
16.15
Weight
-50%
50%
16.56
Weighted Average
PEG Ratio
Ticker
SLCA
HCLP
CRR
Value
0.82
0.53
2.38
1.45
The above figures demonstrate the market valuation in comparison to the firm’s intrinsic
value, providing the potential gain for investors. U.S. Silica’s valuation is comprised a
benchmark comparison against industry competitors: Hi-Crush Partners LP (HCLP), Carbo
Ceramics Inc. (CRR). Both HCLP and CRR comprise a significant amount of the industry
earning a 50% weight each. When evaluating U.S Silica through all but trailing P/E (TTM
P/e), we see that the firm is currently undervalued.
Sector and Sales Growth
Projected Revenue Growth
Oil & Gas
ISP
Sales Growth
2013
30.00%
2.50%
17.7%
2014
29.00%
2.50%
18.65%
2015
28.00%
2.50%
19.40%
Termina
2016
2017
2018 l
15.00% 15.00% 6.00%
6.00%
2.00% 2.00% 1.50%
1.50%
11.23% 11.55% 4.91%
4.94%
Over the next few years, we expect for the Oil & Gas sector to continue to be the more
lucrative of the two sectors. Although we expect growth to continue, we anticipate a decline
in growth due to increasing environmental concerns, and changing energy markets. As
demonstrated in the chart above, ISP will continue positive growth, but at a minimal rate in
comparison to Oil & Gas.
Financial Ratios
Gross Margin
SG&A/Sales
Operating
Margin
Tax Ratio
CAPEX/Sales
Inventories/S
ales
2013
43.16%
9.35%
2014
2015
44.09% 44.93%
9.35% 9.35%
2016
45.35%
9.35%
Termina
2017
2018 l
45.75% 45.89% 48.31%
9.35% 9.35% 9.35%
22.46%
30.00%
18.65%
23.39% 24.23%
30.00% 30.00%
16.04% 9.50%
24.65%
30.00%
8.54%
25.04% 25.18% 27.60%
30.00% 30.00% 30.00%
7.66% 7.30% 6.96%
9.01%
9.01%
9.01%
9.01%
9.01%
9.01%
9.01%
In the upcoming years, we expect the Gross Margin to improve due to sales from the higher
margin Oil & Gas segment becoming a larger part of U.S. Silica’s revenue. Although U.S.
Silica fronts transportation costs and other operational services provided free of charge to
U.S. Silica’s clients, the volume of their sales will offset the costs. Additionally, oil prices are
expected to rise, increasing transportation costs for U.S Silica. CAPEX/Sales are anticipated
to decrease due to recent expansionary projects inflating CAPEX. Normal operations do not
require the levels of capital expenditures U.S. Silica has had in recent years. We expect
steady, constant growth in Inventories/Sales with continued sales success with current clients.
U.S. Silica must address the concern of altering pricing over time to adjust for the sales
growth.
Actual $ Millions
2010
2011
2012 Histor
70
107.074
243.765 ical
Financial Statements
Oil & Gas Proppants
Industrial & Specialty
Products
Sales
COGS w/ D&A
Depreciation and Amortization
COGS excl. d&A
Gross Profit
SG&A
Operating Income
Tax Rate
Ebit * (1- Tax rate)
Data
175.397
244.95
157.994
19.305
138.689
86.959
21.663
45.991
4.86%
43.76
188.522
295.60
181.52
20.999
160.521
114.4
35.198
58.203
12.31%
51.04
19.305
15.241
64.5
32.194
22.418
7.748
15.754
9.05
1.51
73.088
27.458
53.356
20.999
66.745
59.199
50.495
29.307
36.568
42.167
11.534
6.364
67.064
48.44
20.982
25.099
105.719
61.022
59.564
39.835
16.846
42.723
9.483
2.433
62.923
59.705
11.265
-5.53
-15.69
-3.55
Depreciation
CAPEX
Cash & cash equiv
Accounts Receivable
Inventories
Other current assets
Accounts payables
Accrued expenses
Current maturities of LTD
Other current liabilities
Working Capital
Change in Working Capital
Free Cash Flow
198.156
441.92
253.54
25.099
228.441
185.386
41.299
118.988
25.76% Forec
88.34
ast
$ Millions
Financial Statements
Oil & Gas Proppants
Industrial &
Specialty Products
Sales
COGS w/ D&A
Depreciation and
Amortization
COGS excl. d&A
Gross Profit
SG&A
Operating Income
Tax Rate
Ebit * (1- Tax rate
2013
317
2014
409
2015
523
2016
602
2017
692
203
520
296
208
617
345
213
737
406
218
819
448
222
914
496
Termina
2018 l
734
778
225
959
519
229
1,006
520
30
35
42
47
52
54
57
296
345
406
448
496
519
520
195
237
289
325
366
386
429
49
58
69
77
85
90
94
116.7
9 144.32 178.46 201.96 228.92 241.47 277.76
30%
30%
30%
30%
30%
30%
30%
82
101
125
141
160
169
194
Depreciation
CAPEX
Cash & cash equiv
Accounts Receivable
Inventories
Other current assets
Accounts payables
Accrued expenses
Current maturities of
LTD
Other current
liabilities
Working Capital
Change in Working
Capital
Free Cash Flow
30
97
72
70
47
20
50
11
35
99
85
83
56
24
60
13
42
70
102
99
66
28
71
16
47
70
113
110
74
31
79
18
52
70
126
123
82
35
88
20
54
70
132
129
86
37
93
21
57
70
139
136
91
38
97
22
3
3
4
5
5
5
6
74
70
88
83
105
100
117
111
130
123
137
130
143
136
11
13
16
11
13
6
6
4
24
81
107
129
147
175
U.S Silica will reverse past negative free cash flows by rapidly growing in 2015 throughout
2018. By 2016 U.S. Silica plans to improve their revenues by implementing a premium per
ton of fracking sand sold, which will contribute significantly to their future revenues. In
addition, we believe that the growth of value added products will attribute to the increase in
free cash flows and sales. Meanwhile, increased value added products will require greater
inventories, which could negatively impact carrying costs. U.S. Silica has vast opportunity to
improve the ISP sector, as construction projects increase. According to Bloomberg,
construction spending throughout 2014 has climbed to a four year high (Stilwell 2013).
As U.S. Silica increases their debt holdings, they will incur debt at the rate of 5.82%. The
environment over the next few years will also be determined by “green” technologies and
changing regulatory policies, which could alter the security of revenues and cost of debt.
Discount Rate and Valuation
Cost of Equity
Market Returns
Risk Free Rate
Market Premium
Beta
Cost of Equity
Cost of Debt
Credit Rating (Estimated)
Total Cost of Debt
WACC Calculation
17.067%
2.70%
7.30%
1.67
14.89%
Valuation
WACC
Discounted Value of
Firm
Less: Market Value
Debt
Equity Market Value
Shares Outstanding
9.70%
$2,437.84
$252.00
$2,185.84
53.4
B1
Intrinsic Value
5.82%
4.20% Current Price
$40.93
Total Debt
$252 Return Prospects
27.92%
Total Equity
$267
$32.00
Total Value
$519
Tax Rate
0.28
WACC
9.70%
Worst Case DCF
Projected Revenue Growth (Worst Case)
Oil & Gas
ISP
Sales Growth
2013
20.00%
0.00%
11.0%
2014
19.00%
0.00%
11.33%
2015
2016
2017
18.00% 15.00% 10.00%
0.00% 0.00% 0.00%
11.47% 10.12% 7.04%
Termina
2018 l
5.00% 3.00%
0.00% 0.00%
3.62% 2.20%
In our worst case scenario, we asked what would happen if more states place moratoriums on
fracking. Given that the EPA is delaying a decision on the environmental impact of fracking,
and states with large shale basins will most likely allow fracking to continue, and moratorium
by “lesser fracked” states will have a limited effect on U.S. Silica. Our DCF for the worst
case gives an intrinsic value of $27.16
Financial Analysis
Sales Growth:
Since its IPO U.S. Silica’s sales have almost doubled, and increased by 49.5% between 2011
and 2012. Increasing revenues have stemmed from increased building and acquiring new
mines, and offering logistical services to clients. We expect that increasing mine presence
close to customers will alter U.S. Silica’s operations to become more like a retailer rather
than wholesaler. We do expect continued increase revenues throughout 2018.
Investment Risks
Internal Risks
Centered generation of sales
About half of U.S. Silica’s sales are brought in from two plants. One is located in Ottawa,
Illinois and one in Mill Creek, Oklahoma. If any kind of detrimental event were to happen at
either of these two plants, such as a major industrial accident or damaging weather
conditions, it would have a major impact on the financial situation and production of U.S.
Silica. Similarly, if any unfortunate events affected the customers that these two plants serve
or the availability of the products needed to provide U.S. Silica’s services, it would have the
same affect.
Ability to renew and obtain required permits
U.S. Silica is required to possess governmental, environmental, and mining permits in order
to do business. If for some reason authorities decided to reject US Silica’s request for a new
permit or remove a permit that U.S. Silica already possess, it would negatively impact their
ability to perform services for U.S. Silica’s various customers.
Inability to acquire financing needed for growth
U.S. Silica operates in an industry that requires a high level of capital expenditures to
maintain operations and develop new mines. U.S. Silica must be able to obtain significant
financing at attractive interest rates in order to operate its facilities and grow. U.S. Silica’s
ability to obtain this financing will be influenced by numerous factors such as market
conditions, and U.S. Silica’s financial situation when additional capital is required. If U.S.
Silica is unable to raise the necessary capital at attractive interest rates, the company’s ability
to grow could be hampered, and its financial condition could be negatively affected.
Silica Related Health Issues
Inhaling silica is associated with the lung disease silicosis. Links have also been made
between the inhalation of silica with lung cancer, and other health issues. Concerns over
potential adverse health effects, as well as concerns regarding potential liability from the use
of silica, may discourage customers’ use of silica products. The actual or perceived health
risks of mining, processing and handling silica adversely affect the company. U.S. Silica has
been the subject of numerous lawsuits alleging damages from silica exposure by former
employees. As of December 31, 2010, the company was subject to approximately 146 active
silica exposure claims, and, as of January 17, 2012, approximately 3,156 inactive claims.
External Risks
Demand for commercial silica
If the demand for commercial silica by customers of U.S. Silica decreases, it could have a
significant effect on U.S. Silica’s operations and financial position. The demand for
commercial silica by end users is influenced by many different elements that cannot be
controlled or predicted. For example, global and regional economic conditions, the prices and
supply of fuel, oil and natural gas, fluctuations in demand for residential and commercial
construction along with demand for automobiles, competition from foreign producers of glass
products, and technology advancements influence on demand for products.
Operating risks of commercial silica industry
US Silica is exposed to multiple risks that revolves around the processes and the production
facilities used in this industry. Price changes and the availability of transportation, natural
gas, and electricity play a substantial role in the operations of US Silica. The mining that is
done by US Silica can be affected by unexpected environmental hazards such as cave-ins,
rock falls, pit wall failures or other weather conditions such as flooding. On top of this, there
are also chances for industrial accidents such as fires or explosions that could stall or
completely shut down production.
Development of alternative proppants or processes
U.S. Silica produces considerable amounts of frac sand that is used in hydraulic fracturing to
generate natural gas and oil wells. Frac sand is currently the most used proppant for hydraulic
fracturing. If demand for another proppant increased and took away the demand for frac sand,
U.S. Silica would experience drastic effects on their production and operations. On the other
hand, if a new process was developed that proved to be more efficient or less costly than
hydraulic fracturing, the demand for frac sand would drop immensely.
Federal and state legislative restrictions or bans on hydraulic fracturing
Hydraulic fracturing is currently supervised by state and local government authorities but is
excluded from federal regulation. The U.S. Environmental Protection Agency is in the
process of researching the environmental impacts hydraulic fracturing can be associated with.
If negative results are discovered from the EPA’s studies, hydraulic fracturing could become
more highly regulated. This could lead to additional requirements for companies to
participate in hydraulic fracturing along with restrictions of hydraulic fracturing altogether.
Increased regulation of hydraulic fracturing could potentially increase costs and decrease
production for U.S. Silica’s customers leading to less demand for frac sand.
Loss of relationship with top customers
U.S. Silica’s top ten customers made up close to half of their sales from operations with the
top customer representing no more than 9% of U.S. Silica’s total sales. U.S. Silica has only
reached long-term supply agreements with three of its top ten customers. If any of the
remaining seven top customers decide to stop doing business with U.S. Silica or cut back on
the amount that they purchase from U.S. Silica, it would have a strong negative impact on
their operations and financial performance. This could happen due to various reasons such as
the customers establishing their own source of commercial silica or deciding to work with
another company that supplies consumers with commercial silica.
Disclosures:
Ownership and material conflicts of interest:
The author(s), or a member of their household, of this report does not hold a financial interest in the
securities of this company.
The author(s), or a member of their household, of this report does not know of the existence of any
conflicts of interest that might bias the content or publication of this report.
Receipt of compensation:
Compensation of the author(s) of this report is not based on investment banking revenue.
Position as a officer or director:
The author(s), or a member of their household, does not serve as an officer, director or advisory
board member of the subject company.
Market making:
The author(s) does not act as a market maker in the subject company’s securities.
Disclaimer:
The information set forth herein has been obtained or derived from sources generally available to the
public and believed by the author(s) to be reliable, but the author(s) does not make any
representation or warranty, express or implied, as to its accuracy or completeness. The information is
not intended to be used as the basis of any investment decisions by any person or entity. This
information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy
or sell any security. This report should not be considered to be a recommendation by any individual
affiliated with, CFA Institute or the CFA Institute Research Challenge with regard to this company’s
stock