06 Oct Smart Sand: Short Squeeze Thesis Undone – Smart Sand, Inc. …
Investment Thesis: Smart Sand is incredibly undervalued on a book value basis, but the short float has risen in the month of August. This article seeks to explain why the short float has increased in Smart Sand and if the short thesis was ill timed or is outright wrong.
Smart Sand (NASDAQ: SND) is an undervalued powerhouse in the proppant supply sector. If you read my previous article Smart Sand: Why The Permian Basin Doesn’t Matter you can see why I think Smart Sand is an excellent company. With Smart Sand being so undervalued, you can imagine my shock when I noticed the short float had increased since I wrote that article. I began to wonder what grounds these investors had for shorting the stock.
While short interest was much higher earlier in the year and has been decreasing since, August is when the short float began to rise once again. This correlates well with the price per barrel of oil dropping below 60 dollars. Also during this period a wave of bankruptcies hit the proppant sector. According to FastMarkets:
A wave of mine closures, bankruptcies and leadership struggles has spread through the United States’ frac sand market over the summer, while producers struggle with a glut of oversupply that is keeping prices low.
Frac sand prices nosedived in late 2018 after a huge volume of new supply came online. Prices have remained stagnant since then, even while demand rises.
This pricing struggle has plagued the industry and prevented expansion for players within the industry, some larger producers even idled mines in order to cut costs. This wave of bankruptcies could explain why the industry is most likely being shorted, but why was Smart Sand was targeted?
Smart Sand Liquidity and Lawsuits
Smart Sand is one of the lowest leveraged companies in the industry. How can this company then be targeted as a possible bankruptcy risk? For starters, Smart Sand has a low level of cash on hand. Much of Smart Sands current ratio is tied up in receivables.
Smart Sand’s lawsuit against Schlumberger over a frac sand off-take breach of contract has left a good portion of its current assets in limbo. This litigation, according to the most recent earnings call, is tying up at least 14 million in receivables (source). This is included in their earnings but not contributing to cash flow. Since this hurts Smart Sands liquidity it is understandable that bears would think Smart Sand is in trouble.
Since these receivables have a possibility of never being collected, we need to take a closer look at Smart Sands Cash flow for vulnerabilities. Back in March Smart Sand had a positive cash flow and most recently went slightly negative.
Smart Sand has most recently been paying of its debt load and even set a bit aside to buy back a tiny amount of shares (Source). Smart Sand has also stated in its earnings calls that it plans to pay off its debts and stockpile cash while waiting for sand prices to rise. Once sand prices begin to rise again I’m sure Smart Sand will be in an excellent position to expand and grow at a fast rate.
Smart Sand is focusing on growing its customer base with its take or pay contracts. One way Smart Sand is doing this is through logistics and branding.
Logistics and branding as an Economic Moat
While Smart Sand has low cash levels and is pursuing litigation, I believe shorts have chosen the wrong company to target. Alongside the improving conditions in the industry, Smart Sand is a leading company in vertical integration and sports efficient, industry leading transportation services.
Smart Sand excels at not only supplying high quality low priced sand, but its logistics capability is what makes the company a formidable sand production and logistics company. Smart Sand acquired Quickthree solutions last year and since then has incorporated their last mile trucking and storage solutions into their brand.
Smart Sand has an industry leading ability to move sand to the Bakken basin for the same price as in basin sand. They achieve this by having a fully integrated facility that can processes high quality sand all in one place. This coupled with extremely cheap rail transportation from production site to directly in basin access allows them to remain competitive and even thrive.
Smart Sand is essentially entrenching itself and creating an economic moat by making sure every step of the logistics process from mine to well-site is seamless. This along with its Smart Sand’s branding strategy on silo’s and unit trains allows customers to proudly associate with and expand its brand. Some customers have even remarked “they are the nicest looking thing in the basin.” (source) Referring of course to their sand silos.
Geopolitical Pressure a Short Thesis Undone
Back in August the short thesis looked pretty strong for the proppant supply sector. Especially since many proppant suppliers are declaring bankruptcy due to low frac sand prices. At this point Smart Sand probably looked like an easy target, with its litigation and low cash levels.
However, in September the attack on Saudi Aramco’s refining facility off-lined a great deal of the world supply of oil. This has been touted as one of the largest disruptions in the oil industry, ever. Some experts are even shocked at how little the world supply of oil has been affected. We may still have yet to see the ripple effects of this attack. Not to mention the situation remains unresolved and further instability is possible.
This geopolitical event pushed oil prices temporarily over 70 dollars a barrel. But over the past 6 days has dropped to around 52 dollars its lowest levels of 2019 (source). While oil prices are separate from frac sand prices the two are highly correlated and the price of Smart Sand has tracked this upward and downward oil momentum exactly.
The recent glut of bankruptcies of many frac sand suppliers will inevitably increase sand pricing to…