Morningstar | Maintaining Smart Sand FVE After 4Q Results Despite Earnings Surprise
After reviewing Smart Sand's surprisingly strong fourth-quarter results in depth, we are maintaining our fair value estimate of $3 per share. Adjusted EPS of $0.19 in the quarter handily beat the consensus average of $0.13, resulting in the company's shares rallying over 50%. Smart Sand now looks like the the most overvalued proppant company we cover, trading about 45% above our fair value estimate.Along with peers, Smart Sand's results deteriorated sequentially owing to the decrease in overall frac sand demand stemming from the slowdown in U.S. shale well completions. Therefore, Smart Sand volumes decreased 26% sequentially. However, gross margin per ton increased to $37 per ton from $33, owing to $4 per ton in higher contract shortfall revenue. This meant that the overall hit to Smart Sand's results was fairly modest compared with peers, which also experienced a sharp decline in margin per ton.
As the contract shortfall revenue shows, Smart Sand is benefiting from what is currently the strongest portfolio of contracts in the industry. Almost all of the company's fourth-quarter volumes were sold under contract, benefiting average pricing. Additionally, the pricing mechanism for most contracts is using oil prices at a one quarter lag--average oil prices in the third quarter 2018 were quite high, therefore inflating contract pricing. Furthermore, most of the contracts were signed in 2017, when average proppant pricing was quite a bit higher than our long-term midcycle forecast of $26 per ton mine-gate.
Unfortunately for Smart Sand, its average contract duration is only two years, offering only limited protection against industry headwinds. Therefore, we think the market has overreacted to the positive short-term results for Smart Sand. In the long run, we think Smart Sand will post a gross margin per ton of about $15, in line with peers.
Smart Sand is a frac sand supply and services company. The company is a producer of Northern White raw frac sand, which is a proppant used to improve hydrocarbon recovery rates in the hydraulic fracturing of oil and natural gas wells. The company also provides proppant logistics solutions to its customers through its in-basin transloading terminal and wellsite storage capabilities. The company markets its products and services primarily to oil and natural gas exploration and production companies and oilfield service companies and sells its products under a combination of long-term take-or-pay contracts and spot sales in the open market.
Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors.
Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.
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