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  • Writer's pictureGreystone Capital

An Asymmetric Opportunity with Select Sands Corp. (SLSDF)

Company Data (as of 07/01/18)

Ticker (US Shares): OTC: SLSDF

Price: $0.35

Market Cap (fully diluted): $30.2mm

Shares Outstanding (fully diluted): 97.5mm

TTM EPS: $0.01

P/E: 30x

TEV: $35mm

TTM EBITDA: $832k (Q1 2018)

EV/EBITDA: 10.9x (Q1 Annualized)

Every so often, I’ll start researching a business and find out a few key things that allow me to move forward with additional due diligence. The first is whether I am capable of understanding the business model, and the second is if there seems to be some sort of undervaluation that might present an opportunity to achieve a 2-3x return with minimal downside within a few year time frame. Asymmetry is what I’m looking for.

In the case of Select Sands Corp., this opportunity checks nearly every box in terms of investment criteria for Greystone Capital, and fits snugly in my wheelhouse in terms of an underfollowed business with a clean balance sheet, run by a high quality management team, trading at an absurdly cheap valuation.

Select Sands represents an opportunity to invest in a frac-sand producer trading at a fraction of the company’s private market value and future earnings, with a distinct geographical advantage to various other frac-sand providers and an experienced management team with a long-term horizon and solid operational and capital allocation abilities. While relatively unknown (or at least that’s the impression I get) to the broader market – no sell side research, no analyst coverage, trades OTC, 767 SA followers versus 14k and 15k for SLCA and HCLP – this $35mm EV company has made significant strides since commencing operations in January 2017, and is now fully ramped to supply capacity of up to 1mm tons of sand to its end customers.

An investment in Select includes taking on significant commodity risk (despite the demand, sand is a commodity subject to supply and demand metrics), as well as illiquidity and energy sector risk, which would cause most to walk away right there, but I believe Select possesses a few unique attributes among oilfield service provider companies and other frac-sand producers, including their geographical location, quality of frac-sand, barriers to entry (no one else owns their asset), clean balance sheet (small net debt position), and small size allowing them to absorb some market share while still remaining a relatively small player (a few percentage points of market share). In addition, I see the company being able to ramp well past their guided short-term 1mm ton run rate with little additional capex and built in demand for their product.

Select is a miner and provider of frac sand to the oil and gas industry, where participants are beginning to benefit from favorable pricing dynamics over the next few years given tightness in supply, increased usage of sand per drilling well, and the large demand for high quality northern white frac sand (Select’s main product, more on that below) to the tune of 80-100 million tons in 2018.

Prices for frac sand are forecasted to increase significantly over the next few years as oil and gas producers are using more frac sand per well than anyone ever imagined, which has brought frac sand companies to the forefront of the energy sector in an urgent way over the next few years.

What caused my ears to perk up when researching Select includes the size of their sand properties, ability to build out additional capacity, geographical advantage to major basins in Texas, a clean, nearly debt-free balance sheet with access to plenty of additional capital (debt funding), and a management team with operational and industry expertise, alignment with shareholders, and long-term view.

Select barely reached profitability (EPS of $0.01/share) as of Q1 2018, but my expectations are that will be the start of a positive trend forward starting next quarter, with the company shipping a record amount of frac-sand, increasing revenues, benefiting from a favorable pricing environment, and generating positive adjusted EBITDA and net income.

In addition, having commenced operations in January of 2017, the company is quite simply in the first inning of the opportunity in front of them, having mined only 10-20 acres of their 520 acre property (only one of two properties), yet still proving out capacity (due to hit 600,000 ton run rate in Q2), increasing revenues, solidifying logistics, increasing customers, and pushing toward positive EBITDA and cash flow generation.

Barring a major downturn in oil prices and collapse of the energy sector, Select has positioned itself to deliver on their capacity guidance of 1mm tons of frac sand shipped in 2018, increased production, capture cost efficiencies by aggregating operations to one facility, and generate earnings in the range of $4-5 million. I estimate a fair value somewhere in the range of $1.50 – $2.50 USD by 2020, given Select’s untapped growth, proximity to major oil and gas basins, production increases, and increased industry demand for Tier 1 Northern White frac sand over the next 2-3 years.

As mentioned above, further driving the thesis is the fact that the market remains unimpressed – or what I think is happening – unaware. Shares have hovered around $.30/USD for quite some time, with no recognition for any of the positive developments that the company has made. Right now – assuming one was to purchase the entire business – Select is a $31mm EV company with the power to generate $9-11mm in EBITDA over the next 12-18 months.

Although a quick look around the frac-sand space in terms of publicly trade companies would reveal that all of these businesses – given commodity and industry risk – are priced at cheap multiples, Select is trading at cheaper forward multiples than all their publicly traded peers, and seems to have the largest runway in front of them, ability to capture additional market share, most favorable geographic advantage, cleanest balance sheet, and appears to be the actual low-cost producer of frac sand in terms of cost per ton. Add in what I feel is the one of the best management teams in the industry, and I’m on board to step back and let management deliver shareholder value moving forward.

As Joseph Cafariello of Energy & Capital once said: “If oil is black gold, then ‘frac sand’ is gold dust. The fracking boom in America could not advance nor even exist without frac sand or its synthetic imitations. The mining, processing, shipping and transloading of frac sand has become a whole new gold rush unto itself.”

As the price of oil has recovered, E&P companies have emerged leaner, with the ability to drill at lower break-evens, they have resumed capex, and rig count hit the highest level since 2014. Select is poised to deliver on this increased demand and favorable pricing environment, as they are ramped up to deliver 1mm tons of capacity into an environment that is ready to absorb it.

**Of note, one of the hurdles I have with making new investments is high insider ownership. Select does not meet this criteria yet, with management owning around 2.1% of the company. With that said, I’ve gotten zero indication based on company visits, talking with management, channel checks that this management team is anything but shareholder friendly. I believe them to be taking a long term view, acting very conservatively, concerned with sources of capital, and see no dilution risk at any time in the near future (which I will outline in more detail below).

Company Overview

In the company’s words, Select Sands Corp. is an industrial Silica product company developing its 100% owned, 520-acre Northern White, Tier-1, silica sands project located in Arkansas. Select Sands’ goal is to become a key supplier of premium industrial silica sand and frac sand to the North American markets. Select Sands’ Arkansas property has a significant logistical advantage of being approximately 650 rail-miles closer to oil and gas markets located in Oklahoma, Texas, New Mexico, and Louisiana.

To echo the above, the company mines frac sand, and sells it to large oil and gas players for use during the fracking process. The company’s end customers are located in the major basins in Texas, including the Permian. According to my channel checks, direct-to-E&P is the fastest-growing sales channel in the space. Frac sand makes up just about 100% of company revenues, with a very tiny segment of revenues coming from the shipment of gravel and stone that is basically residue from the drilling and mining process. Select is a pure-play frac sand company, with a singular focus on mining and selling their Northern White Tier 1 frac sand, the highest quality and most in-demand frac sand in the industry.

The business model is relatively easy to understand, as the company mines the sand, moves it by truckload to their processing facilities to be washed and then dried, stores it at their finished product site, and then ships the sand again by truck to their company owned rail site where the sand is taken by rail car to a Union Pacific track, and then to their end customers. Select has also started shipping sand via barge, which further reduces costs, and allows the company to move more tonnage per boat than rail car. What started out as an experiment due to some flooding and weather issues has now become a viable part of the business, with Select reported that nearly 40% of product is currently being shipped by barge.

Select sold just under 500k tons of frac sand in 2017, and is on pace to reach a 1mm ton run rate in what appears the next 12 months. This 1mm run rate would represent less than 1% market share (demand of 100-120mm tons in 2018-2019), but based on my due diligence, site visit and conversations with management, one can get an idea that management is thinking much bigger in terms of the long-term potential of their assets. I wouldn’t be surprised to see Select eventually reach a run rate of 3-5mm tons, especially after the consolidation of their facilities onto one property (Independence) taking place as we speak, and should provide some cost synergies (less trucking to be done back and forth between processing facilities) as well as increase production efficiency.

For those familiar with mining businesses, normally going from discovery to production (the prospecting, sampling, testing of a property to drilling) can be a process taking anywhere from 2-3 years, with relatively low capex and operating expense requirements when compared to say mining for gold or other precious metals. However, Select has been able to get up and running and moving toward full capacity with minimal investment, expenses and headaches. What makes Select unique are its proven resources, pent up demand for frac sand, geographical location to major basins, additional capacity ramp without the need to tie up tons of capital, clean balance sheet, and low-cost producer advantage.

As it stands now, Select’s assets and owned properties consist of Sandtown, Bell Farm, their processing facilities (wet and dry), their finished product storage facility, and their rail site where the sand is transported. These properties were acquired at very favorable prices (some at the bottom of the energy cycle in 2015-2016), and have spawned an incredible amount of value creation in a short period of time given their favorable location and high quality of product.

For those not familiar with how sand plays a role in the fracking industry, I’ll offer a brief explanation. Fracking is the process of drilling into the earth and injecting a mixture of high pressure water, sand and chemicals in order to force open what are called ‘fissures’ in the rock, and extract any oil and gas deposits from a particular area/well.

To get the gas from these fissures, producers have to shoot water and sand down a well while the fluids split open rocks to release trapped oil and gas. The sand plays a crucial role because it wedges into these cracks and keeps them open so that hydrocarbons can be pumped out.

A simple Wikipedia diagram should help illustrate:

wikipedia-diagram.png

The reason why a particular type of sand such as Tier 1 Northern White is so important, is because this process puts an immense amount of pressure on the tiny grains of sand, resulting in a need for a very particular type of sand, or ‘high specifications’.

Getting back to Select, the company has a favorable logistic and geographical advantage, being located within a short trucking radius to the most prolific oil and gas basins in the US.

mine locations

Select currently owns two large sand mine properties made up of their in-process mine Sandtown, and a recently acquired additional property called Bell Farm. Here’s a look at the company’s two properties, both of which have an acreage of 490-520 acres.

mine details

As mentioned above, Select has a geographic advantage to serve the Eagle Ford and Permian Basins in south and west Texas. Major competitors with mines/quarries in the favorable geology setting of Wisconsin, Minnesota and Illinois are at a serious logistical disadvantage in supplying the oil and gas fields of Texas. Transportation distances are a key cost factor, since logistics can account for up to 60% of delivered cost of frac sand. And in general, sand resources in Texas produce Tier 2 and Tier 3 sand, which until recently, was unsuitable to use in the fracking process. Currently Tier 1 sand deposits in Texas have been insufficient to meet local demand.

Four of Select’s major customers account for approximately 95% of total sales for the period ended March 31, 2018, and approximately 88% of total accounts receivable at March 31, 2018 are due from these four major customers. From what I understand, somewhere between 50%-70% of revenue is contracted, with the remaining balance being sold on a spot pricing basis. Having studied the industry and become familiar with competitors, this 70% contracted rate seems on par with the rest of the industry.

Although very helpful, it doesn’t appear that the thesis is tied to a continued rise in crude oil prices, given the drop in sand supply, increased amount of sand being deployed per well, demand for Northern White, and shipping cost advantages that Select possesses. The company has proven their product, grown their customer base, increased their shipped sand run rate, and lowered costs. In other words, not a lot has to happen for value to be realized. Furthermore, tightening supplies and logistical challenges should bode well for frac sand prices, with an increased pricing environment and continued favorable demand trends.

Company Background

In October 2014, Select entered into an option to acquire a 100% interest in the 520 acre prospective property, which was acquired for $936,000, $200,00 of which was paid upfront. This was the Sandtown property, which was acquired form an informed seller who now works with Select as an operations employee.

Some 2015 background on the property from an external source:

The Sandtown quarry site is underlain by the St Peter Sandstone Formation. This well-known formation is host to a number of producing Tier 1 frac sand operations including ones owned by Hi Crush and US Silica. A phase 1 drilling program was conducted on the northern 200 acres of the 520 acre property in December 2014, followed by a resource definition phase 2 infill drilling program in February and March 2015. All drill holes except one encountered high purity (99% SiO2) silica (30/50 mesh 7K, 40/70 mesh 9K and 100 mesh 10K) over intervals averaging 52 feet with the longest intersect being 110 feet, which incidentally was open-ended. A Quarry Mining Permit Application was submitted to the Arkansas Department of Environmental Quality on April 16, 2015, and within three weeks, an unconditional 5-year Authorization to Quarry was received. The company has commissioned Tetra Tech to complete a NI 43-101-compliant resource calculation and a preliminary economic assessment (PEA). Based on the drilling campaigns, management’s non NI 43-101 compliant resource estimate is 8-10 million tonnes of frac sand.

*Of note, the correct resource estimates for Sandtown now stand in the 40mm ton range.

The better illustrate what the property looks like, the following paragraph comes from a write-up on microcapclub.com, where the author had recently flown down to Arkansas to tour the facilities and visit with the management team. I was on that trip as well which I discuss in more detail below with accompanying photos. I thought it would make sense to include another investor’s summary of this part of the trip – the tour of the quarry (mining site) – as opposed to mine. It would be difficult for me to add any additional value to the description below.

After driving on a two-lane paved road, we turned off onto the recently completed 2-mile long private road (cost 300k to construct) and within a couple of minutes were at the quarry. The parcel of land is just over 500 acres, and all the mining to date has occurred on a 10 acre section. The photos I’ve posted below start with the quarry and progress on the timeline of our day. What immediately struck me, was how white the sand was. It’s important to note that this was raw, unwashed product. Premium sand has little or no clay, nor other impurities. The St. Peter sandstone is one of the oldest silica sand deposits in the US (likely 450 million years) and typically the younger the deposit, the lower the quality. The other key attribute of their sand is how easily it crumbles.  When you pick up a “rock”, it crumbles in your hand, so their is no additional step of having to run it thru a crusher to de-cluster it. The bulk of US sand utilized by the O&G industry, comes from Wisconsin, which for most users is a long and costly trip to the well site. The present 10 acre site utilizes a common mining technique called “bench mining”. The property has very little overburden, so no costly digging before reaching sand. They scoop out the sand to predetermined depth, then they move the walls in about 30-40 feet, then repeat the process four times. When they drilled the property for the pre-feasibility study, they went down about 140 feet at this specific location and were still hitting sand. Of course the idea is to optimize the ability to maneuver the trucks, loaders etc in a timely fashion, so total depth mining is not ideal, especially when they have another 500 acres + of sand to extract. Most of the trucks we saw, were not corporately-owned, but contractors. To get the sand into the trucks, a loader utilizes a scoop that holds about 6 tons of sand, with four scoops making a full 25 ton truckload. Each truck makes 5 or 6 trips every day from the quarry to the wash plant which was about 20 minutes away. Given that sand is relatively cheap commodity (pricing is a widely guarded secret, but lets call it  $30-60 ton), any viable operation wants to minimize the distance from quarry to finished product. Trucking product between the quarry to wash plant to dry plant then onto barge or rail car, costs between 15-25 cents per ton per mile.

COO Rasool Mohammad deserves a ton of credit for researching properties, and locating the Sandtown quarry that the company has in process. According to management, Rasool looked at nearly 200 properties before purchasing the land for around $1mm.

To give an idea of the inherent value in this purchase price, US Silica purchased a facility w/ a 4mm ton run rate capacity for $225 million, or around $56 million per ton. This is an asset with a 30 year life. Select paid $1mm for their Sandtown property capable of ramping to a 1mm ton run rate within the next year, or $1.00 per ton. Sandtown also has around 50 years of sand at the current production rate. It appears that the asset’s replacement value is somewhere around $30mm, and the opportunistic timing as mentioned above was due to finding an distressed seller looking to cash in on the property for whatever he could get. I thought it was important to outline the above to illustrate management’s bargain hunting ability (something we’ve seen again with the Bell Farm property and the rail site) and the potential return on the initial investment into the property. Using the US Silica example as a guide, Select paid pennies on the dollar for similar production and better geography, so I’m bullish on management’s ability to create shareholder value moving forward.

Given where the company started, and length of time since inception, I’ve been very impressed with what Select has been able to accomplish so far, and it’s become clear that management saw an opportunity, and pounced on it.

operations timeline

The year ended 2017 – the company’s first in operations – was a huge step forward in terms of unit volume and revenues, and Select is now building upon their early success, and positioned to benefit from sand price increases, capacity additions which will drive increased volume, and continued low cost transport.

2017 operational highlights

From a standing start in 2017, Select generated around $830k in adjusted EBITDA in Q1 2018, and is guiding for 130k – 150k tons shipped in Q2, and EBITDA most likely breaking $1mm in the second quarter.

unit volume and EBITDA

The company’s operating history is short, but growth metrics are strong, there is room for further margin expansion, and investors should expect increased pricing for frac sand and continued demand over the next few years. Average price increases have been in the 13% range, and tonnage is increasing at a rapid pace.

Business Strategy

The US has always held a dominant hand in the frac sand market given the quality of product, and there a few other key drivers that separate quality frac sand companies from the lesser players. Those include:

  1. Quality

  2. Quantity

  3. Transportation methods

  4. Exchange rate

  5. Supply/Capacity

A cardinal rule in logistics management is that the supply chain grows increasingly complicated, the longer it stretches, the more volume it must deliver, and the faster it must move.

To give an idea of the importance of a geographic/logistical advantage looks like, Canadian frac sand companies will haul their product some 3,000 km or more from the upper Midwest to the big shale companies in Northern BC and Alberta, adding about $50-$150 in transportation plus exchange rate costs.

Select Sands goal is to become a premier provider of Northern White frac sand to the oil and gas industry.

about select sands

While not mentioned directly, the company is aiming to grow their market share, increase their customer base, and continue to ramp capacity to deliver north of 1mm tons of sand per year. Demand for Northern White frac sand is at favorable levels, prices are increasing, and management has met or exceeded each goal they’ve set out to achieve thus far in building the business. I believe estimates for increased tonnage, cost savings and EBITDA have been conservative to date, and guidance appears achievable moving forward.

As discussed above, some of the key characteristics of Select’s sand properties/assets include:

  1. Favorable geographic location

  2. Ability to ship via barge

  3. Low cost production/streamlined operations

  4. High quality sand – Northern White only

  5. Additional acreage to mine

Over the past 12 months, Select has undergone a number of initiatives in order to unlock value including differentiated transportation methods, efforts to further reduce costs, the purchases of their rail site and new Independence property, and even supplying additional types of sand to their end customers. All of these efforts will/have resulted in increased capacity and efficiencies, and April/May were some of the company’s best months, shipping over 50,000 tons of sand. The company has guided for 130,000 – 150,000 tons to be shipped in Q2 2018.

Although sand pricing is somewhat of an industry secret, and not a ton of reliable data exists, from what I understand Select has somewhere between 50-70% of revenue contracted with large oil and gas players, with the remaining balance being sold on a spot pricing basis for somewhere around $50-60 per ton. While some may question the strategy of not locking in pricing with long-term contracts (an approach some of Select’s competitors take) I believe this to be a smart way to go about things given the remaining volume can be priced on the spot market, where higher prices can be taken advantage of. In addition, many competitors have built in price escalators based on the price of oil that move pricing per ton upward as oil increases. The company doesn’t employ a designated sales force, but rather an ‘all hands on deck’ approach, where the CEO and COO are fielding calls and orders from customers. As of now, given industry demand, they’ve received a lot of inbound interest and haven’t had any issues with generating leads or selling finished product. As it stands right now, management is focused on the continued ramp to a 1mm ton run rate, capturing any additional cost savings, and educating their customer base about the asset and what they have available.

It doesn’t appear that the company has to do much in order to achieve the desired run rate, just continue with the status quo. Barring a major industry downturn or pricing collapse, the company can continue to spend somewhere around $1mm in maintenance/growth capex (2% of 2018 sales) and should be able to grow revenues, increase their customer base, and hit their projected target.

There will be more commentary to add once the Independence property is fully operational, but management has indicated that the new processing facility will be capable of pushing through 3mm tons, and as part of their eventual expansion, the rail loading facility will also be beefed up to 110-150 rail cars which should all result in additional cost savings.

According to management, there was a more efficient way for the company to ramp to 1mm tons and optimize operational costs at the same time rather than keep things status quo. By consolidating the washing/drying/crushing locations there should be synergies, as the company will be using the same equipment, but eliminating a 30 mile trucking route to move the sand around.

In addition, the barging of sand (currently 40% of volumes) has been beneficial from day one in terms of cost savings and transport capabilities (load volumes). Barging provides excellent cost savings due to the fact that the sand due to the loading and unloading process. Barging is Select’s preferred method of shipping, but as of now the company is focused on providing what their customers ask.

Management is being conservative on future expansion and growth plans after guiding to 1mm tons. Based on what I’m seeing, 1mm tons appears to be somewhat of a first inning mark for Select, and it appears as though the management team is thinking bigger. Given that the company is profitable, there are some clear macro tailwinds, a path to increased volumes is clear, and an untapped balance sheet exists, the current valuation appears to be incredibly cheap, and Select appears to be in solid shape to deliver shareholder value moving forward. Although potential acquisitions are not a part of the thesis, and management has not indicated any interest in a sale, I’d have a hard time believing that at a 1mm ton run rate Select wouldn’t be attracting the attention of some of the larger players such as SLCA or HCLP.

Valuation

Let’s start with some quick ‘back of the napkin’ math in terms of valuation. As always, it’s all but a guarantee that my estimates and model will be wrong.

Management feels very confident that the beginning of their push toward full capacity starts with reaching 1mm tons of sand by 2019-2020. Given the 2018 run rate of 600k tons, that’s a big leap, but as demand continues to chug along and cost efficiencies are reached by consolidating operations to the company’s Independence property, I don’t see 1mm tons as that big of a stretch in the near future.

Current average pricing (let’s call it contracted + spot) is around $50/ton given a reverse engineer of Q1 numbers ($5.5mm revenue/92,000 tons). If we multiply 1mm tons by $50/ton that gets us to $50mm in revenues, and with 20% EBITDA margins we are looking at $10mm EBITDA. Placing an 8x multiple on $10mm in EBITDA gets us to $80mm (way less than what I believe it would cost an acquirer to take the business private). Backing out net debt of $0.7mm gets us to a $79.3mm equity value. Dividing by 97mm fully diluted shares get us to a share price of $0.81. While I’m never one to target a specific per-share value, the range I’ve been able to come up with for 2019 is anywhere from $0.81 – $1.10/share. I feel as though I’m being conservative.

Modeling the numbers got me to a similar price per share by 2019 (I’m not going to attempt to model anything further than next year) applying a 12x multiple to Select’s earnings, and incorporating the following assumptions:

  1. 2018 numbers are based on 92k tons shipping in the first quarter, plus flat rate of 150k tons (mgmt. guidance) for the next three quarters

  2. Revenue based on pricing per ton, which I’m applying a 10% pricing increase each year from 2017 numbers – I feel this is conservative as management stated they have seen 13% price increases across the board through Q1

  3. $4/ton cost savings with Independence property on the back half of 2018 is factored into the model in 2019 by raising gross margins to 25% from 23% through Q1 – conservative

  4. I don’t want to annualize Q1 2018 results given pricing changes and fluctuation in tonnage, however, operating expenses for 2018 are Q1 annualized

  5. I did not work off of company guidance and assume ramp to full capacity of 600k tons in 2018, bur rather used 542k tons (Q1 + 150k *3) but then used 1mm tons in 2019

Earnings table

Source: Author Data

I visited the company in May, at which point I was told April was the best month in company history in terms of per tonnage shipments of sand (50k/month). Getting to 83k tons/month within two years given current sand demand and pricing doesn’t appear to be wildly unrealistic given current numbers, and points to the fact that we are in the first inning of Select’s growth and capacity.

There will always be the commodity/logistics risks among other things, but my visit to the facilities at least passed the ‘sanity test’ where I was able to see finished product, shipping operations, how well executed the operation is and how poised they are to ramp to full capacity. The company is currently being asked for more product than they can ship. The jump from 300,000 tons to 1mm tons is certainly no small feat, but to imagine Select getting there within the next 12-18 months is not a crazy notion.

In addition, I think there is somewhat of a misconception surrounding the barriers to entry that I’ve seen written about. Many think that frac-sand business has low barriers to entry given it’s commodity status, and capital being the only meaningful differentiator between a company that mines/produces it and one that doesn’t. I’d argue that in addition to capital, you have to take into consideration the quality, logistics and expertise to get a sand operation up and running. Since most frac-sand businesses trade at modest multiples, and Select has those three differentiators, they should actually be trading (or eventually should be) at a premium to other frac sand companies, even given their small size and tiny share of the market. I have been able to see the pieces that need to be in place for a company like Select to generate shareholder value, and there’s no aspect of their operations that appears to be easy.

I see Select being able to generate somewhere in the range of $10-11mm in EBITDA by 2019 at full capacity, while keeping the share count flat, and minimal usage of their credit facility to expand, purchase new equipment, begin the ramp on Bell Farm etc.

Assumptions

  1. Tap an additional $3mm in credit facility by 2019

  2. Keep a small cash balance on hand

  3. Fully diluted shares stay constant

  4. Premium to the median peer multiple

  5. Aggressive EBITDA estimate based on full ramp to 1mm tons shipped

EBITDA table

I believe investors have the opportunity to capture value in the range of 2x or more the company’s current valuation with minimal downside to the investment thesis. Lastly, if additional industry consolidation is expected, the acquisition of Select’s properties by other large frac sand companies would generate tremendous synergies. The industry is ripe for M&A activity, and it appears as though a Tier 1 frac sand asset that has proven resources and is being monetized would be attractive to any of the major players. With that said, I believe Select will generate value outside of any potential acquisition and feel great about partnering with a quality management team who has been under-promising and over-delivering.

Scuttlebutt

A key tenant of my investment philosophy revolves around what Peter Lynch used to call ‘scuttlebutt’, or obtaining information from sources outside of the company, including customers, suppliers, employees and competitors. As one approaches the information gathering process, trying to learn things not covered in the company filings becomes paramount, and this is where conversations with management, site visits and studying competitors adds a ton of value.

With Select, it became important to understand the technical aspects of the company’s operations, and doing an up close and personal site visit was the best way to accomplish this. Luckily, I had a group of investors heading down to Batesville, AK who offered to include me in the trip in late May 2018.

Before I touch on some details relating to my visit, let’s start here. There is an incredibly high-quality discussion taking place about the business on microcapclub.com, where members of the MCC (who have to be voted in by their peers based on an investment analysis, or pay a steep subscription price) are discussing the company, analyzing the business, and working through the investment thesis. Here’s a link to the page:

Included in the discussion are details about our trip to the facilities, and some of the investors on the tour covered the trip in much better detail than I will in this section.

It’s worth pointing out about mining companies; there are times when a business announces the operation or acquisition of a thousand or million ton mine site, where perhaps they’ve done a feasibility study and put up some equipment. That may not mean they are actually shipping thousands or millions of tons immediately. So the first thing Select had to do for me was past the ‘sanity test’. The company is guiding for a 1mm ton run rate let’s say over the next 12-18 months, so is that actually available to sell to customers?

The short answer is yes, and any concerns I had before visiting the company facilities were put to rest when I was able to see the 520 acre quarry property, the processing facilities, the finished product, and truck after truckload of sand being moved from place to place during the few days I was there. For the skeptics among us, one could argue that the company had set all of this up specifically for our site visit (they knew we were going to be there), but the odds of that are close to 0%, and would have been very difficult to have the employees present and working, the machinery going, the processing taking place, and the truckloads of product being shipped all for ‘show’.

The visit also helped outline the actual size of the opportunity in front of Select, as mentioned above, the company has been able to achieve results to date by mining only 10 acres of their 520 acre property, and they have another nearly 500 acre property in Bell Farm as well. Barring a massive oversupply issue, or huge downturn in demand, it seems very likely that Select should be able to hit their 1mm ton run rate fairly soon, and even think about pushing past that number.

I’ve posted some pictures below of my visit, with short descriptions of each.

Three pictures below: the quarry, where the sand is mined and put into large piles to be transported by truck to the processing facilities

Below: the washing facility, where the sand is washed and cleaned and again put into large piles to be trucked off to the drying facility – notice how white the wet sand is

IMG_1928

Below: the sand is dried, and any remaining rocks, minerals or debris are removed. Again, notice how white.

IMG_1926

Three pictures below: the rail site where truckloads of finished sand are taken to be dumped into a grate in the floor, and carried from the conveyer belt to a large pipe and loaded onto each rail car.

And finally, we have the finished product facility where the mined, cleaned and processed sand sits.

To give an idea of how much sand is blasted through one cubic foot of an oil or gas well – in the picture below, the small pile of sand to the left right by the opening of the structure is 2,500 lbs. of sand (little pile on the ground to the bottom left of the picture).

sand arrow

Risk Factors

  1. Shareholder dilution – the company has access to cheap capital via bank debt, with this regional bank being able to increase capacity at which they loan. To date, management hasn’t issued shares to fund growth and feel that dilution risk is very low.

  2. Sand price decreases – the rapid buildout of additional capacity may cause sand prices to drop. To date, we are still seeing price increases across the board, and I will continue to monitor pricing levels and management commentary across various frac-sand producers for hints at any downturn in prices or oversupply.

  3. Additional production costs – given that Select has already purchased the assets they need to reach 1mm tons of production, I see relatively small costs from here on out and no huge increase in leverage, increased borrowing or high additional costs

  4. Transportation and logistics issues – this one is perhaps out of the company’s control, but sustained logistics issues (flooding, weather, rail car issues) would affect per quarter tonnage being shipped to end customers. So far things have been on track following Q1 (that affected every producer).

  5. Barge transport never materializes – right now, Select is shipping around 40% of their product via barge, an efficient and low cost way to ship sand. Were that to change, and shipping costs escalated, I’d be forced to re-evaluate the thesis moving forward. Access to barge is an important part of the company’s model

  6. Price of oil crashes – the thesis should work out favorably barring a major energy sector downturn, recession, or severe drop in oil prices

  7. Companies switching from Northern White to in-basin sand – right now, in-basin sand represents only a portion of available capacity being used by E&P companies. As detailed above, Northern White is higher in quality and more in-demand even given it’s higher cost to ship. However, a complete shift from Northern White to in-basin sand would cause me to re-evaluate the thesis

  8. Small fish in a large pond – can never gain share, low barriers, no niche

  9. Current trend of increasing proppant use per lateral foot decreases – halts or reverses

  10. Government regulations – there have been no regulations imposed to date

  11. Product concentration – as mentioned above, a large drop in demand for Northern White would clearly hamper the companies operations and cash flows

Today, Select Sands is in better shape as a business than when shares were trading around $1.50 last year, with barely any tonnage shipped and no history of earnings or cash flows. Barring a major energy sector downturn, and the combination of factors including a severe drop in oil prices, an extreme and sudden oversupply of Northern White frac-sand, discontinued E&P activity, and a large drop in the price of the company’s product, my estimates of the downside risk of an investment in Select Sands is less than 15-20% drop in the current share price, with the opportunity to 2-3x investor’s capital.

Conclusion

Select represents the potential for investors to 2-3x their capital with minimum (less than 15-20% downside) risk, given a combination of macro tailwinds, solid management, unique assets, a clean balance sheet, and the ability of the company to meet industry demand. The next few quarters will outline the runway in front of the company, and continue to paint the picture of Select as an eventual premier provider of Northern White Tier-1 frac sand.

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