Investment Matters

Northern Silica Corporation: Ready for take-off

This week we wanted to share with clients the progress Northern Silica has made.  (For the benefit of long-term clients, Northern Silica Corporation (NSC) was formerly named Heemskirk).  Northern Silica is currently being run as an unlisted company, whilst it is being readied for, firstly, large-scale production, and secondly, re-listing or a trade sale.

Northern Silica Overview

Operating for 20 years, NSC is Canada's only producer of 'white' silica sand.  It is located in Golden, British Columbia. 

Due to increasing use of silica sand for fracking, the demand in Canada has risen from 2 mtpa (million tons per annum) 7 years ago, to a forecast 6-8 mtpa in 2019.  Brown sand meets ~1 mtpa of this demand.  Historically, at least 75% of the sand used in Canada (including sand used for industrial uses) has been imported from the US (primarily Wisconsin).

When it comes to supplying Canadian oil and gas producers, NSC benefits from a substantial cost advantage.  This is primarily due to the location of its sand, which, being in close proximity to its customers, gives it a $100/t transport cost advantage over US producers.  NSC is ideally positioned to considerably expand and displace a substantial volume of the sand currently being imported from the US.  Its cost advantage is so significant that even if producers in the US only charged their customers for transport costs (i.e. $0/t gate pricing), NSC would remain profitable through all points of the cycle.

NSC has a measured resource of 37mt, however its inferred resource is substantially larger at  99mt (measured is a more certain and tested category of resource).  Through 2019, the business will prove up its resource, which we expect will lead to a measured resource substantially above 100mt. At its initial restart rate of production (300,000tpa), NSC can be in production for 92.5 years (based on its measured resource only).

 

 Untitled Above: Mount Moberly Mine (Golden, British Columbia)

 

Given the opportunity and size of its resource, NSC plans to incrementally build production capacity in a manner that maintains the market price and maximises the economics (and ultimately the return on the resource) of the company. The potential upside from this is substantial.

Production started successfully and ramping up through 2019

We are pleased to inform clients that production is ramping up on schedule.  As can be seen below the effect of an extreme 'polar blast' (which resulted in –20c temperatures for an extended period during February) made consistent operation difficult.  That said, the business still managed to finish the March quarter (its first full quarter of production) 13% ahead of its production target for this stage of operation.

NSL chart v2

Sales and revenue are growing strongly on the back of this production.  We are pleased to see NSC's excellent grade of sand is now being sold and highly regarded by customers.

Demand for NSC’s product is strong despite current weak sand prices, highlighting its quality.  Currently, US sand miners in Wisconsin, as a result of excess capacity and fixed 'take or pay' rail contracts, are dumping equivalent quality sand in Canada for an effective $0 at the gate price (i.e. they are only charging customers for transport costs).  This is only rational while these rail contracts are in force, and will revert to market pricing as the US industry rebalances.

Notwithstanding prices being at a low ebb, NSC has been selling sand at the market price while still being able to make ~$30/tonne (operating) profit on what it sells.  This period of low pricing has demonstrated the resilient economics of the business, which have now been tested and proven.  This is a huge tick in proving up the long-term value of the business.

As import prices revert to a more economic level (we expect this to occur during the 2H 2019 and 1H 2020) and production increases to name plate levels (the output levels NSC's plant is rated for) through the Northern Summer, NSC will be able to make strong profits.

As a result, the business has now moved to a growth footing.

In order to be positioned to sell the business and achieve a price that recognises its true value, the company will need to 'prove up' the ultimate size of the resource base, diversify its current product offering (selling its more refined by-product sand to industrial users) and further develop future expansion plans.

Furthermore, whilst NSC is a significant investment for us, and a reasonable sized business, the reality is that at it is effectively operating a 'trial' plant.  This plant will help form the blueprint (with many lessons learned) for a larger ~2mpta plant, under a different (well-funded) owner. This scale of plant is common in the US and represents significant operational upside.

We expect that, once operating 'normally', the sustainable operating cash flow from the 300,000tpa plant will be $20-22m p.a. At NSC’s current market value, this equates to a total value of business to cashflow of <7x.  With the ability to expand the business significantly, we see NSC as highly compelling for an industry player (or private equity).  To give an indication of the potential return for clients: in May 2018 the largest US player paid 12.5x Cashflow ($750m) for a similar business, which did not have the expansion upside this business has.

Sometime in 2020/2021, NSC will be well positioned to consider its options and look for a more appropriate owner. This should conclude what has been a long, but ultimately lucrative journey for First Samuel clients.