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Subject:  Hard Core Core Date:  11/17/2012  5:40 PM
Author:  LeKitKat Number:  12395 of 24465

Sometimes you think you understand a company and appreciate its business model only to go back a few years later and find the analysis got buried in details and was completely useless.

I did that with Core Labs and failed to buy because I missed the point. Hope to get it better this time through. Still not a buyer, but at least I know why.

Core Labs is in the oil services sector. Core has a moat of sorts at least for now. The moat is the highly technical high margin reservoir analysis they go after and their workforce of 1300 scientists that tend to stay with the company –turnover of 2%.

They have some competition in certain areas of the business. In products, Schlumberger sells instruments that directly compete. But in providing comprehensive high quality core sampling, well diagnostics and project planning, there is little direct competition.

CLB enhances and manages oil and gas reservoirs. The company can tell a client about the three fluids in a reservoir (oil, gas, water) and about the characteristics of the rock and whether it will let the fluids flow. This business falls under reservoir description and part of the service is analysis of core samples; where they get their name. Some of the business is done out of the field and at refineries providing analysis of octane in gasoline and blended gas.

Production enhancement includes perforating products that explode downhole and fracture rock to let fluids flow. Core also designs completions of wells to ensure maximum recovery of fluids. They are good at fracture design and procedure, production flow and allocation and cementing and casing depth control.

Reservoir management integrates the information from the other two segments and designs game plans to maximize production.

Case study from the Q3 CC

A client was trying a certain type of completion technology and needed details on how the fracturing was most efficiently and economically produced over the length of the well:

Rob MacKenzie - FBR Capital Markets

So effectively, as the clients – as operators try these more, they spend the money and time on analyzing it so it’s a net positive for you guys?

David Demshur

That is correct. We’ve got a good example in the Granite Wash, where it was a 21-stage completion. They used the sliding sleeve technology. And after they completed their stimulation, the well flowed exactly what they thought it would flow, so they thought they had a very successful completion and stimulation of all 21 stages. What our tracers did show that the first nine stages did not take any stimulant and all the production was essentially from the last 12 stages. So that client, in the next drilling operation, used plug and perf, and made their best well that they ever have.

So it’s on a case-by-case basis, Rob, but it is providing additional fracture diagnostics services to the company.

The company is always looking for new technology. CLB is now in the process of developing reservoir saturation technology that identifies reservoirs that absorb water allowing production of more hydrocarbons This came out of observations while working with Petrohawk. The higher flow rates for wells were creating less permeable rock. Ultimately they found by slowing and even choking the wells led to higher total recovery. Those observations will be turned into advanced capabilities to look at the porosity of a well and its relationship to flow.

Key tenets of Core’s business philosophy

High returns on capital

First and foremost they will not take on business that is low margin and doesn’t meet their threshold return on investment. When they design their business segments and take jobs, it’s always the high return work they are looking for. For that reason they have refused to do on well-site analysis of samples like mud logging. Mud logging is a relatively low margin analysis of sediment and rock that is recovered as the well is drilled. Their business in core sampling, especially in deepwater reservoirs, is much higher margin with less competition. The reservoirs are difficult and complex and require certain expertise.

David Demshur

Are other individuals and companies doing lower-tech, lower-margin projects? For sure, no question about that. But the market that we address, we have not seen any serious competition enter, nor do we think we will see any serious competition enter in the near future.

Returns to shareholders

In addition to maximizing returns on invested capital, the company is dedicated to returning value to shareholders. CLB has been buying back shares and paying a small dividend. There were 53.8 million shares (adjusted for split in 2010) in 2006 and that was whittled down to 47.5 million shares in Q3 2012. Options abuse is non-existent. However, the company issues a large number of restricted shares. In 2011, 177,255 restricted shares vested compared to just 42,000 options. The options are performance-based compensation for management and restricted shares are given to employees to help retain them. The overall employee turnover rate is 6% and turnover for the scientists is only 2%.

2011 2010 2009 2008 2007 2006
Diluted Shares 48.39 48.24 46.66 47.89 48.82 53.78

Repurchases have been less effective over 2010-2011. Dilution in 2010 was due to settling 2006 warrants adding 706,395 shares in addition to restricted shares. Stock buyback slowed in 2011 to only 10,000 shares and $1 million spent at $110 per share.

For the past three years, share repurchases totaled 1.2 million shares vs. 116,000 in options exercised. Total paid was $125 million. In 2012, share counts are down to 47.5 million and the repurchase strategy has been more effective.

Core Labs also pays a dividend that has been increasing for three years. The yield is 1.1% and the payout ratio is only 25%. I would expect per management comments a series of dividend increases going forward.

Free cash flow

Free cash flow is the third key business principle guiding Core Labs. They are careful with capital spending and demand high returns. They will not spend unless the returns meet their threshold at around 30% to 40%. That goes for both capital expenditures and acquisitions. In the first nine months of 2012, $1 out of every $6 in revenue was converted to free cash flow. Around 2/3 of capital spending goes for growth and the rest is maintenance.

While ROIC is high, free cash flow yield is low at 3.3% compared to leaders in other sectors, but holds its own against two big companies in oil services -- Halliburton is in negative numbers for free cash flow and SLB has a free cash flow yield of 4.4%.

From the Q3 CC:

Based on the most recent calculations available from Bloomberg, Core’s return on invested capital was the highest of any company in the oil field services comp group listed by Bloomberg Financial. And also, Core’s weighted average cost of capital was the lowest.

12/2011 12/2010 12/2009 12/2008 12/2007
ROIC 45.5% 32.4% 29.1% 39.6% 36.3%

The weight average cost of capital is 8.8% and the spread between WACC and ROIC is widely positive.

Capital spending is two-thirds growth and their careful approach to spending has not sacrificed growth or margins. The company’s policy to stay away from low margin work and stick to their high margin circle of competence has kept margins remarkably stable and growth high.


12/2011 12/2010 12/2009 12/2008
Revenue 14.2% 14.2% -10.9% 16.4%
Gross 11.9% 18.1% -10.6% 20.2%
Operating 14.5% 21.5% -9.8% 12.6%
Net 27.4% 27.6% -13.4% 18.0%

Gross 34.6% 35.3% 34.2% 34.1%
Operating 28.6% 28.6% 26.9% 26.5%
Net 20.3% 18.2% 16.3% 16.8%

Business has been slowing in 2012 and September 2012 growth is considerably less than September 2011.


09/2012 06/2012 03/2012 12/2011 09/2011
Revenue 6.1% 9.4% 13.3% 17.1% 16.1%
Gross 11.2% 23.3% 21.6% 20.2% 10.3%
Operating 18.6% 24.8% 32.3% 18.4% 5.5%
Net 21.3% 30.8% 16.6% 32.9% 15.8%
Gross 36.7% 36.7% 36.3% 36.8% 35.0%
Operating 30.7% 29.2% 31.6% 29.9% 27.5%
Net 22.2% 21.4% 23.0% 21.8% 19.4%

Q3 2012 proforma operating growth 6.1%
Q3 2012 proforma net growth 11.6%

The natural gas business continues to disappear and CLB has been pursuing oil related business. They expect gas rig activity will continue to wane into the fourth quarter. Core’s revenue mix is closer to 80% oil and 20% natural gas, a shift from the previous 70%-30% earlier this year and in past years.

Q3 2012

In 2012 worldwide activity in oil and gas was essentially flat. Despite decreasing rig counts and the transition to oil from gas, Core managed revenue growth. In 2009, even they could not pull off positive earnings growth and if we head down that path again and see global recessions, 2013 will look a lot worse than just the slower Q3 2012. Core expects growth to continue into 2013.

Q3 combined revenue increased 6.1% year over year. Business is seasonal and year-over-year is the only way comps make sense. The reservoir description segment with exposure to Canadian oil sands revenue comes in primarily in Q2. Reservoir description revenue increased 4% in Q3 2012 and 13% in Q3 2011. It’s clear that 2012 growth is beginning to lag 2011 and 2013 could be even slower.

Production enhancement with only 4% growth is still mainly dependent on North American well completion and stimulation. The decrease in rig counts has slowed growth.

The slowing revenue growth is seen across the two largest business (description and production) segments and in consolidated revenue growth.

2012 2011
Reservoir Description 4% 13%
Production Enhancement 4% 23%
Reservoir Management 45% 2%
Consolidated 6% 16%
Operating income (loss):
Reservoir Description 28% 3%
Production Enhancement 5% 17%
Reservoir Management 72% (37)%
Consolidated 19% 6%

The oth