Solaris oilfield outlook
Taking the Long Term Approach to Solaris Oilfield
Solaris Oilfield Infrastructure, Inc. manufactures and rents mobile proppant and chemical management systems to unload, store, and deliver proppant and chemicals at oil and natural gas well sites in the United States. The company currently employs 380 people and operates in the United States’ major oil fields such as Permian, Eagle Ford, STACK/SCOOP, Marcellus, Utica, Haynesville, Rockies, and Bakken, and Kingfisher. Proppant is the sand that is utilized by E&P companies in the fracking process, a critical element in the exploration and producing of oil. The company offers services as a rental, which reduces the costs for pumpers as well as offering last-mile logistical services and inventory management through the Solaris Lens software application. The company has seen incredibly impressive growth over the last three years, as they have increased the number of proppant management systems from 29 in Q4’16 to 166 in the most recent quarter, an increase of 5.7x. In total, 2019 has largely been a success financially, even though they have been forced to navigate an increasingly difficult industry environment. In 2019, SOI became free cash flow positive for the first time and has maintained profitability for the past three quarters. The main reason for this is a massive reduction in Capex spending, as growth in the industry has stagnated and actually began to fall.
The largest struggle facing Solaris is the tightness in upstream producer’s yearly budgets, as depressed oil prices have reduced the profitability of pumping oil. Over the past three years, the company had been growing feverishly to produce enough of their systems to meet demand, but as operators began to cut their budgets for the rest of 2020 and cease operations, their utilization rate has begun to fall. In the third quarter, only 115 of the 166 systems were fully utilized, meaning they were operated every day in the quarter. This represents a 7% reduction in utilization rate compared to a year ago, the clearest indicator of revenue. In their prepared statements on Q3’s conference call, the firm expects frac activity in the United States to decline sequentially by 20-30%. Anecdotally, SOI management has found that some upstream operators are simply shutting down wells even before they are completed, just because the economic return is not worth it in the current market conditions, mainly low oil and natural gas prices. The slowdown in the industry certainly affected Q3 results and should continue to worsen at least into Q4. The company expects its utilization to match closely with activity rates in the broader US market, inactivity of 20% is likely. The company has fixed yearly contracts, so pricing is not a concern to the company, and they expect to maintain prices throughout 2020, which will be key for revenue figures going forward. The company anticipates growth in activity beginning in Q1, as well as operators, secure their new 2020 annual budget.
Although the industry has suffered greatly throughout 2019, Solaris’s management team deserves credit for the ways they have reacted to such softness in the market and still improved strong financial returns. Firstly, the company has been able to navigate this storm without needing to take on any external debt, unlike many other service providers that SOI competes with. The firm has an immaculate balance sheet, including $52 million in cash at the end of Q3 and an undrawn credit revolver worth an additional $50 million. The company was quickly able to react to market conditions and began to quickly reduce capital expenditure spending on the development of new proppant systems. By scaling back these expenditures, the company has been able to generate significantly more FCF, with Q3, the company’s YTD total FCF has totaled $56 million. Of this, the firm has returned over $14 million to shareholders in their dividend which was initiated in Q1. The current dividend yield for Solaris is 3.4% given current prices, as they recently announced a 5% increase to .105 cents per share. The company is dedicated to appropriately rewarding shareholders with this FCF, and management is aligned with this priority as executives at the firm collectively hold 16% of the total shares outstanding. Furthermore, early on December 4th, the firm announced the Board of Directors has authorized a share buyback program worth $25 million, which at current prices, would represent approximately 5% of the total shares outstanding. The company believes they will be able to generate stable FCF no matter the current state of the industry, as they guided for up to a 50% reduction in Capex spending in 2020, which will help improve FCF results.
The short term operating environment ultimately looks very fragile in the coming months if not quarters, however, if 2019 has proved to us anything, it is that the management team at Solaris is ready to weather the storm while still showing positive financial results. There are a few short term catalysts that I believe will push this stock significantly hire, but nevertheless, the company is still exceptionally positioned to dominate the market once a recovery begins in the industry. This downturn over the last year has given Solaris the opportunity to look inward and make sure operationally the company is moving smoothly. They can react to customer demands easily, and have been able to further improve the value they can add to customers in the industry. So ride out the storm while enjoying a nice 4% dividend yield and reap the benefits of a strong free cash flow generator, which at given prices, represents a 14% FCF Yield.