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CAPS Contest Idea: Check out CLB

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August 20, 2009 – Comments (0) | RELATED TICKERS: CLB , SLB

We're into Q2 of our CAPS Champion of the World Contest and remember that if you want to win, you need to rate at least one of our official ideas. This is one of those ideas, so go ahead and go long or short it in you CAPS contest profile, and you'll be eligible to win.

Long Core Labs (NYSE: CLB)

Investment Thesis
As global oil and gas consumption continues to increase and E&P costs continue to rise, energy companies will seek to improve production efficiency. This is where Core Laboratories comes in. The company’s reservoir description and production enhancement products and services are the most advanced in the world and help clients determine the best way to drill a well in order to increase the recovery factor to more than 40% (the dramatically low industry average). There is no competitor with similar size or scope and Core Labs should see healthy growth as energy prices rebound and E&P companies invest in growth. Further, thanks to a capital light business model, the company should generate gobs of cash to reward shareholders. 

Valuation and Key Metrics
9.x EV/EBITDA, 15x P/E, 14x P/FCF -- These don’t look classically cheap out of context, but are discounts to a 5-year average P/E of 23.7 and a P/FCF of 15.9. Also looks expensive relative to a peer group of energy services companies (5.5x EV/EBITDA, 11.4x P/E), but is much higher quality (25% ROA, 34% ROC v. 10% ROA, 12% ROC). Best comp is probably SLB, and while SLB has much greater size, CLB more thoroughly dominates its niche with better returns on capital given the more specialized technology.  The company also has remarkable 18% operating margins which are improving given recently instituted cost controls and operating leverage in the services model. The high margins also speak to the quality and competitive advantages of the business.

A DCF of 8% to 10% annual growth over the next 10 years (discounted at 12%) yields a fair value of $90 to $92 per share. That's about where the stock is today, but this is a high quality business, with a competive moat, and significant upside should oil prices rebound more than the current consensus view.

Management
Long-tenured and internally promoted with a greater than 5% ownership stake. The company has also demonstrated its shareholder friendliness by declaring a $0.40 annual dividend last year and paying a $1 special dividend. They were also savvy about repurchasing some convertible debt earlier this year with the cash on their balance sheet at a discount to fair value when the market was panicking about the energy sector. Very focused on cash flow.

Country and Market Opportunities
Obviously, energy exploration and development. But what’s nice about Core is its global reach. Fully 70% of the company’s revenue is derived from fields outside of the US and it has strong ties to EMEA. Given that international energy development held up much better this year than US development thanks to government spending and that we can expect emerging state-run companies to continue to spend, these relationships should help drive Core’s growth even in a volatile energy price environment. Oil sands and US shale opportunities are kickers at this point.

Potential Points of Failure
Core is only brought in after product has been discovered and is ready to be drilled. Thus, if there’s a decline in exploration activity or a decline in energy prices that slows drilling, Core will suffer. The good news is that Core’s margins are not affected by energy price moves…they either get the business or they don’t.

Like it? Don't like it? Let me know in the comments and place your vote in the CAPS contest to be eligible to win.

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