SAC Capital Piles Into Fracking Sand

 | Jun 26, 2013 | 4:00 PM EDT
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A 13G filed with the Securities and Exchange Commission has disclosed that billionaire Steve Cohen's SAC Capital Advisors recently maintained a position of 2.1 million shares in U.S. Silica Holdings (SLCA), a miner of commercial silica, which is used as "frack sand" in the hyrdrofracking process that is currently under way in oil and gas shale plays throughout the U.S. U.S. Silica's products are also used in other industrial operations. SAC appears to have purchased all of these shares since the beginning of April.

Fracking's growing role in the U.S. energy industry has boosted U.S. Silica's sales: Its revenue rose 19% last quarter from the first quarter of 2012. However, the company's costs have also been rising, and the result is that operating and net income showed small declines. All of the increase in business at U.S. Silica came from oil-and-gas-related operations, but as might be expected from the rise in costs, this was due to higher production volumes rather than changes in the price of frack sand. Increases in working capital caused cash flow from operations to be negative for the quarter, though not worryingly so in the context of current cash and working capital balances.

U.S. Silica currently trades at 14x trailing earnings, which is actually close to value territory; apparently, markets believe that there will be little change in the price of frack sand in the future, and so they say that even higher revenue won't lead to much if any improvement on the bottom line. Wall Street analysts, however, are much more optimistic. They predict that earnings per share will rise to $1.67 this year, and then increase further to $2.17 in 2014. That implies a forward P/E of only 9, with continued growth generating a five-year price/earnings-to-growth ratio of 0.5. Note that this leaves plenty of room for U.S. Silica to underperform analyst expectations and still prove to be a value stock at current prices.

Of course, recent financials have shown no earnings growth at all, and apparently many market players see that as a bearish sign for the company. The stock is widely shorted; the most recent data show over 80% of the float held short. U.S. Silica does stand out for having a very close relationship to the movement of major market indices, with a beta of 3.6. However, the company has not been publicly traded for very long, so the statistical relationship might be skewed by the stock's 81% rise in the last year as the market has done well.

Hi-Crush Partners (HCLP) is more of a pure play in frack sand, but it's still a good peer for U.S. Silica. There's very little short interest here, and the company recently started paying quarterly dividends of 47.5 cents per share (which equates to an annual yield of 8.6%). For purposes of comparison, U.S. Silica recently started making dividend payments in line with a yield of 2.4%. Hi-Crush has done a considerably better job of converting its good revenue growth into improvements in net income, which grew by over 70% in the first quarter of 2013 from a year earlier. While markets are more optimistic about the company's prospects -- the trailing P/E is 25 -- analysts are expecting high earnings growth here as well, with the five-year PEG ratio being well below 1.

We're interested in the industry, and despite U.S. Silica's recent troubles, its stock is currently cheap enough in terms of trailing earnings that the market appears to be setting quite a low bar for the company. As a result, we'd be interested in learning more about why it is underperforming its peers in terms of net margins. We do also like Hi-Crush, despite its considerable premium on a trailing earnings basis, and we believe that investors who expect a high level of fracking activity to continue would be well served to look at both companies.

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