Shifting To Free Cash Flow Positivity And Expanding Into Utica Shale Spurs Optimism In Market Prospects

Key Takeaways

• Smart Sand's focus on becoming free cash flow positive and managing costs effectively suggests an upward trajectory in financial health and shareholder returns.
  
• Expansion into new markets and diversification of revenue streams through strategic investments and customer engagement indicate growth potential and operational efficiency improvements.
  
• Fluctuating oil and gas demand, operational challenges, and expansion risks could negatively impact Smart Sand's revenue, costs, and earnings.

Catalysts

An integrated frac and industrial sand supply and services company, engages in the excavation, processing, and sale of sands or proppant for use in hydraulic fracturing operations in the oil and gas industry in the United States.

• The company's recent move to become free cash flow positive, with expectations to maintain this status, suggests an improved financial health which could lead to higher shareholder returns through planned value-returning initiatives, thereby potentially impacting earnings positively.
  
• Smart Sand’s proactive management of its cost structure, including driving down production and administrative costs, has led to improved contribution margins and adjusted EBITDA, laying the groundwork for enhanced net margins.
  
• Investments in new terminals in Minerva and Dennison, Ohio, reflect an expansion strategy into the Utica shale formation market, expected to increase revenue through higher sales volumes and market share.
  
• Engaging new industrial sand customers and establishing a market for its Industrial Product Solutions business appear to set the stage for diversified and expanded revenue streams as new contracts are secured.
  
• With an emphasis on efficiency and cost-effectiveness in product delivery and service, including initiatives to manage labor costs and invest in more efficient mining methods, the company seems to be positioning itself to reduce operational costs and potentially increase net earnings.

Assumptions

• Analysts are assuming Smart Sand's revenue will decrease by -0.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 0.4% today to 15.2% in 3 years time.
• Analysts expect earnings to reach $43.8 million (and earnings per share of $1.13) by about October 2027, up from $1.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 3.3x on those 2027 earnings, down from 69.9x today. This future PE is lower than the current PE for the US Energy Services industry at 17.4x.
• Analysts expect the number of shares outstanding to decline by 3.28% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 8.78%, as per the Simply Wall St company report.

Risks

• Dependence on the fluctuating demand for oil and gas, which impacts frac sand demand, could negatively affect revenue if prices for oil and natural gas decline.
  
• Cost management and efficiency initiatives may not sustain improved contribution margins and adjusted EBITDA if unexpected operational challenges arise, potentially impacting net margins.
  
• Exposure to the challenging natural gas market, where demand may fluctuate significantly due to factors like low current natural gas prices, could lead to reduced sales volumes and pressure earnings.
  
• The operational focus on expanding into new markets, such as the Canadian and Utica basins, introduces execution and competitive risks that could affect the company's ability to grow revenue as anticipated.
  
• The company's success in managing production costs, including transitions to hydro mining and investment in efficient mining methods, is critical to maintaining low operating costs. Failure to achieve expected cost savings could negatively impact net income.

Valuation

• The analysts have a consensus price target of $3.0 for Smart Sand based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $288.5 million, earnings will come to $43.8 million, and it would be trading on a PE ratio of 3.3x, assuming you use a discount rate of 8.8%.
• Given the current share price of $2.11, the analyst's price target of $3.0 is 29.7% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.