Core Laboratories (NYSE: CLB) describes itself as “a leading provider of proprietary and patented reservoir description, production enhancement and reservoir management services for the global petroleum industry. These services enable the company’s clients to optimize reservoir performance and maximize hydrocarbon recovery from their producing fields. The company has over 70 offices in more than 50 countries and is located in every major oil-producing province in the world. The company provides its services to the world’s major, national and independent oil companies.”
Power of 7s (Based on historical figures)
Core Lab derives its revenues:
- 70% from crude oil projects (now it’s 80%)
- 70% from international projects
- 70% from the top 100 oil companies (NOCs, IOCs, Majors, Super Independents)
Power of Product / Services:
HTD-Blast™ (Horizontal Time Delay Ballistic Assisted Sequential Transfer) – introduced by Core Lab to the market in 4Q’10. This new technology is typically combined with CLB’s SuperHERO™ Plus+ perforating charges and gun systems. In 2011, HTD Blast™ was used on 37.5% of rigs drilling long-reach or extended wells on oil-shale reservoirs. The company proclaimed the HTD-Blast™ as the fastest accepted product since the company’s inception. Technological Accomplishment: the product allows companies to reach and frac the “toe” of a horizontal well in 48 minutes or better. Previous technologies accomplished this task in 48 hours.
Miscible flood opportunities – In the company’s presentation, management shows an example of how CLB is an integral part of a project in the eastern Mediterranean where a closed looped system of produced natural gas, nitrogen and CO2 is created, increasing the total EUR of a 40-billion-barrel (BBbl) field by 250 basis points. If we use an extreme case where $100 million is the total cost of the project, an incremental 1 billion barrels (2.5% of total EUR) to the operator’s account at a net price of $60/barrel would generate $60 billion in additional net revenue for the operator – well worth the investment.
Helium – it’s what is next. The company is an admitted devotee of the “Peak Oil” theory. Helium is the world’s smallest monatomic molecule. The company is investing in research and development of a process which uses helium on oil shale plays. One area where the company believes this process will be useful is in increasing the Recovery Factor (RF) for the Eagle Ford Shale. The Eagle Ford currently has a 5% RF; the company discussed (and has discussed in previous conference calls with investors/analysts) the development of a “nano-perm” process/technology using helium to double the RF in the Eagle Ford. Core said it is “two internal technologies” away from turning this idea into a reality. A key component of this nano-perm is the development of equipment capable of measuring ultra-low flow rates under ultra-high pressures. Helium pushed through the Eagle Ford Shale under constant high pressure is expected to sweep liquid hydrocarbons and increase oil recovery. The company already (and regularly) works with clients in the design and implementation of nitrogen and CO2 floods – both are considered too large for use in the Eagle Ford Shale. The second key component of the nano-perm technology is the price of helium, which is selling for $75/Mcfe.
Power of Crude Oil
CLB works in 1,000 of the 4,000 “fields of size” (EnerCom defines “fields of size” as fields with the potential to produce billion-plus barrels over the field’s lifetime). The company adds 40 to 50 fields each year and has set a target to reach 2,000 fields between 2031 and 2035. We don’t find looking out 20 to 25 years to be long – geologically speaking.
The company’s largest markets in North America are the Canadian oil sands, tight oil reservoirs and the deepwater Gulf of Mexico (GOM). The Gulf of Mexico represented roughly 3% of total revenues back in 2008 and, given the U.S. administrations drilling moratorium after the Mississippi Canyon Block 252 (Macondo) accident, only 1% in 2011. According to the Bureau of Ocean Energy Management, Regulation and Enforcement (as of April 13, 2012), since October 10, 2010, 269 new well and revised new well permits have been approved for wells operating in water depths greater than 500 feet.
CLB admittedly is a “Peak Oil” theorist. In 2002, the company developed an internal global oil production forecast that said “88 in ‘08” (88 MMB/D of global production by 2008) and began taking steps operationally and financially to position itself for this event. With the forecast, CLB believed that 88 MMB/D would be the “peak.” According to the EIA, the amount of crude oil, NGL and other liquids produced worldwide was 85.3 million barrels per day (MMB/D) in 2008 and 86.9 MMB/D in 2011.
Separate, but related, soothsayers predicted that a post-Hussein Iraq would produce 12 MMB/D. CLB is taking the “under” on this production forecast. Iraq is currently producing less than 3 MMB/D (2.6 MMB/D in 2010), and CLB does not believe 12 MMB/D is achievable. CLB’s stated mission is to help its customers produce more oil and gas each day and to produce more during the life of the well.
Crude oil fields are more complicated and offer secondary and tertiary operations that need CLB’s services and solutions. Total worldwide petroleum consumption in 2010 was 87.1 MMB/D. Dated Brent closed at US$112.57/barrel on May 11, 2011 and US$121.76 on 11 months later.
WTI crude closed on April 12 at US$103.64, up 5.5% from May 11, 2011. Companies are highly incentivized to rework fields and use CLB’s technologies to produce more each day and over the life of the well/asset. Conventional wells will naturally produce 40% of its reserves (CLB notes that back in the 70s the figure was 38%). CLB makes the point that its services and products are designed to increase a well’s productive capacity by 5% to 10%. If the conventional carbonate reservoir naturally produces 40% of its reserves during the life of the well, CLB’s products can have a measurable impact on a company’s valuation when their operations and processes have the capacity to increase output by 10%. Recall our earlier eastern Mediterranean closed-loop pressurization example to increase a field’s EUR. The complexity of the crude oil field offers more opportunities for future work, vis-à-vis, revenue and cash flow growth for CLB.
The company has limited exposure to dry gas projects in the U.S. Barclays, in its annual E&P spending outlook, forecast global spending would approach $600 billion: “The acceleration in worldwide spending is expected to be led by increased expenditures internationally (up 11%), in addition to solid growth in North America (up 8% y/y). This compares to international spending growth of 20% in 2011, and spending increases in North America of 31%. We believe the majority of companies have taken a conservative approach in setting their initial 2012 budgets, and current oil prices levels (if sustained) would suggest that there is considerable upside to our current forecasts as we move throughout the year. By region, exploration and production spending is expected to rise most meaningfully in Latin America, Africa, Europe, the Middle East and Russia.” Click here for a global spending table.
Barclays noted that E&P spending is based on crude oil prices of $87 for WTI and $98 for Dated Brent crude. We maintain a commodity price deck table which compiled published forward estimates for crude oil and natural gas prices. Click here for the commodity price table. The median estimated twelve-month forward price for crude oil and natural gas is $95/barrel and $3.78/Mcf, respectively.
Barclays did discuss how worldwide 2012 estimated capital expenditures are price sensitive: “Roughly half of the companies we spoke to said they would decrease their capital budgets if oil averaged $80/barrel during 2012, while the other half said $80/barrel would not change their spending plans. Almost one-third would cut back spending by about 10% in that scenario. No companies expressed a desire to increase their budget beyond current plans in an $80/barrel scenario.”
We asked Core Lab how commodity prices impact their annual spending plans. They confirmed that as commodity prices go, their customers are impacted; however, CLB’s CAPEX matches its DD&A rate. We compiled a multi-year chart of how CLB’s annual revenue and cash flows and compared those figures against an index-weighted and a weighted crude oil price using WTI and Dated Brent. Click here for the graph. We do not suggest that CLB is an agnostic when it comes to commodity prices. We do, however, know from discussions with management and customers that CLB’s products are focused primarily on the “P” in E&P. This is an important distinction for CLB as the majority of spending by E&P operators are to keep production flat or enhance production. Schlumberger (NYSE: SLB) is focused on “E.” Discretionary spending and spending cuts happen more frequently with exploration spending; however, dollars invested to increase production from known reservoirs (or with little risk) have the greatest potential for returns, are the most desirable by management and therefore the “last” to be cut.
Power of Financial Statements
The company’s current debt-to-market capitalization ratio is 4%. The company would be comfortable with a debt-to-market capitalization ratio of up to 30%.
Yearly capital expenditures typically approximate the company’s annual depreciation expense. 2012 Capex is estimated to be $33MM.
Capital Intensity (trailing twelve month capital expenditures divided by trailing twelve month EBITDA) at year-end 2011 for CLB is 11% –the fifth lowest rate for OilService companies in EnerCom’s 88-company peer group. For every $0.11 of capital expenditures, CLB generates $1 in EBITDA.
The company forecasts it will generate $200MM of free cash flow in 2012. This represents a 14.8% increase over 2011’s free cash flow of $174MM.
ROIC of 73% is the third highest ratio for all 88 companies in EnerCom’s OilService database.
ROE of 151% is the second highest ratio for all 88 companies in EnerCom’s OilService database.
OilService intensity (increased frac stages, length of laterals, more oil wells being drilled, service complexity) is driving the oil-technology boom and revenues at CLB. As noted earlier, HTD-Blast™ is rapidly being implemented by customers. During the Howard Weil conference Dan Dinges, chairman and CEO of Cabot Oil & Gas, made a special mention of how HTD-Blast™ helps Cabot with its Marcellus drilling program. In 2011, HTD-Blast ™ was used on 3,000 of 8,000 long reach, extended wells drilling for crude oil/liquids, or 37.5% of that particular market.
Operating margins for 2011 were 28%. This figure bests the average margin for companies in the OFS Equipment category, the Land Drilling category, the Offshore Drilling category, the Construction, Offshore Supply and Seismic categories. CLB’s operating margins are favorable compared to the Big 4 OilService companies: Schlumberger 17%, Halliburton (19%), Baker Hughes (15%) and Weatherford (10%).
Core is not over-exposed to dry gas work. But Baker Hughes (NYSE: BHI) is. On March 21, 2012, BHI provided its outlook for first quarter 2012 margins, indicating that its operating profit before tax would be lower than the previous quarter due to rapidly changing conditions in the pressure pumping market in North America and seasonality in international markets. BHI said: “As a result of the continued shift in U.S. rig activity from natural gas to oil and liquids-rich basins and other market forces, the company’s Pressure Pumping product line is currently experiencing: decreased fleet utilization, lower pricing, higher than expected personnel and logistics costs, and shortages of and higher costs for critical raw materials, such as gel.”
The company is guiding full-year 2012 revenues to range between $1.005 billion to $1.045 billion. The company handles 1,500 projects at any one time (some projects last a day, others six weeks or longer). The 1,500 represents ~75% utilization of the CLB work force and infrastructure.
The $1.045 billion in estimated revenue for 2012 represents ~75% utilization of the CLB work force and infrastructure; a 100% utilization revenue rate could be as much as $1.393 billion.
The company’s full-year 2011 Unlevered Free Cash Flow per share was $5.13 versus $4.89 for 2010. The $5.13/share of Unlevered Free Cash Flow is fourth best in EnerCom’s database.
Since 2002, the company returned $1.2 billion, or approximately $24/share, to investors through stock repurchases, settlements of warrants and dividends. Total capital returned to shareholders in 2011 was approximately $327MM or about $6.76 per diluted share.
Power of Valuation and Opportunity
We believe the company’s management team, products and services, balance sheet, associated top-quartile returns and shareholder focus offer the value and growth investor with the type of near-term and long-term opportunity for returns.
The company is running at about a 75% utilization rate, not because of anything on their end but, more pointedly, because their customers are too short-handed to work on more projects. Projects are more complex. CLB’s past and future success is the result of working hand-in-glove with its customers on their projects, which requires having a company project manager directing CLB’s work flows.
Since the company went public in summer 1995 it has outperformed all but five names on the S&P 500.
Investors are telling us that they get the point that CLB is a secular name in a cyclical industry. Using a narrower operating peer group set, we sought to compare CLB’s unlevered cash flow per share trading multiple. On May 11, 2011 CLB’s Price to Unlevered Free Cash Flow per Share (P/UFCFPS) multiple was 18.9 times, or 20% below the peer group’s 22.7 times average. Nearly one year later the P/UFCFPS is 25.7 times. During that same period CLB’s investors realized 43.5% stock appreciation, exclusive of stock repurchases and dividends. Click here for a comparison table. The peer group realized an aggregate stock price loss, excluding dividends, of 11.1%. Who’s over-valued?
