My previous article Proppant Industry Stress Test Part I: US Silica turned out to be the last in the series before the global equity market implosion took hold just over six months ago. That implosion sealed the fate for Hi-Crush (OTCPK:HCRSQ) which filed Chapter 11 in July (exited in early October) and for Covia (OTCPK:CVIAQ) which filed Chapter 11 at the end of June and is still working through its reorganization plan. You may recall that Emerge Energy Services filed bankruptcy in Q2 2019. Besides U.S. Silica (SLCA), Smart Sand (SND) is the only other remaining proppant industry player not to file for bankruptcy protection. Needless to say, Parts II and III of the series never occurred.
The idea behind the stress test series was based on a request from a frequent Seeking Alpha contributor and commenter, but there’s no need to talk more about stress tests because this year was a definitive bottom with oil temporarily trading (at least on paper) in negative figures. Q4 2019 remains one of the most stressful quarters for the hydrocarbon industry, but pales in comparison to Q2 2020. Companies that survived without filing bankruptcy are obviously resilient, but could they simply be zombie corporations that are unlikely to ever repay their debt obligations? This article will provide a succinct update about U.S. Silica and attempt to address whether the company is, in fact, a zombie. Please reference my first article for a U.S. Silica company overview and introduction to some key terms.
(U.S. Silica Logo, Trademark U.S. Silica)
Summary & Significant Updates
- Proppant sales are down 67% from the year-ago quarter, but did improve 15% over Q2 of this year.
- Proppant margins have rebounded back to levels not seen since 2018 by nearly doubling vs. the year-ago quarter, but the O&G segment continues to be an albatross and U.S. Silica continues to write off enormous amounts of goodwill every year to account for it.
- ISP sales are nearly flat from the year-ago quarter with margins taking an approximate 5% haircut.
- O&G service (Sandbox) revenue have declined 77% and 82%, respectively, the year-ago quarter.
- ISP continues to make up just over 57% of U.S. Silica’s total contribution margin, but this part of the business isn’t growing yet.
- Net debt repayment isn’t going anywhere fast with long-term debt reduction of approximately $8MM/year
- Net cash position has declined by approximately $50MM since 12/31/19
- Q3 evidenced the lowest SG&A since the time before the EP Minerals acquisition at just over $27.22MM, but together with $19.27MM in interest expense (at only 5%), there’s a drag of $46.5MM each quarter against nearly $69MM in gross profit leaving just $22MM ($88MM/yr if this trend continues) for additional cash cushion, debt repayment and growth capex.
The data compilations and charts below based on SEC filings help illustrate the story. Notice that U.S. Silica has remained FCF positive for the last six quarters through progressive cuts to capex and “rightsizing” the business.
Please see this article if you’d like to know more about the importance of EDBA and why adjusted EBITDA is not a trustworthy figure as it relates to U.S. Silica’s business. EBDA does not take tax benefits (such as from prior year NOLs) into account, but also ignores interest payments which are a significant expense for U.S. Silica.
The tables below display a majority of U.S. Silica’s future liabilities. You can easily compare the YE 2019 tables with the Q3 2020 tables. Future purchase commitments have actually increased while lease liabilities have decreased but also extended. Post-retirement benefit obligations have increased nearly 20% YoY.
Investopedia describes zombie companies those that “earn just enough money to continue operating and service debt but are unable to pay off their debt.” While U.S. Silica has the capability to make minimum debt payments, spend some growth capital and simultaneously generate FCF, the company is closer to a zombie than a living, breathing entity. While multiple quarterly earnings calls (including the most recent call last week) have mentioned increasing debt repayment through ISP growth in a rosy future that begins no earlier than 2022, the reality is that U.S. Silica may have a difficult time refinancing its $1.2B term loan maturing May 2025 for favorable terms given that the current LIBOR+ floating rate is 5%. Even if U.S. Silica quintupled its net debt reduction to $50MM/yr, the company would still face a $1B loan refinance obligation in 2025.
I’ve read the rumors about others in the OFS industry like Solaris Oilfield Infrastructure (SOI) merging with U.S. Silica. Given the aforementioned debt load, combinations like this make no sense. OFS companies that do not own sand mines have successfully avoided the value destruction that U.S. Silica is still wrestling. For its part, U.S. Silica has written off so much of its proppant business that I would not be surprised to eventually see a company that’s ISP-only. At present, an ISP-only business will not pay the bills.
If you’ve enjoyed this article, please consider clicking the “Like” button below.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.