Better Buy: Core Laboratories N.V. vs. Frank's International N.V.

While oil prices haven't been as strong as most expected this year, the market is slowly healing. Crude oil inventories, while stubbornly high, have been gradually draining thanks to several years of underinvestment and OPEC's production reductions. Because of the improvement in market fundamentals, most oil field service companies remain optimistic that 2017 will be a better year for business.

This outlook suggests that oilfield service stocks should perform well this year, especially niche players Core Laboratories (CLB) and Frank's International (FI). That said, while both stocks could thrive in an improving oil market, one stands out as the better company to buy.

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The financial checkup

The oilfield service industry is capital intense since these companies typically need to buy expensive equipment to help producers drill and complete new wells. Because of that, most companies borrow heavily to finance equipment purchases, which can prove problematic when industry activity levels head south. That said, Core Laboratories and Frank's International aren't like most rivals:

Data source: Frank's International and Core Laboratories.

While Core Labs does have some debt, it's minimal for a company of its size. Further, through a combination of internally generated free cash flow and an equity offering, the company paid off half its debt last year to further shore up its balance sheet amid a worsening oil market downturn.

Meanwhile, Frank's International continues to avoid debt at all costs. That was evident last year when the company acquired Blackhawk Specialty Tools for $321 million. Instead of borrowing to finance that deal, the company used a combination of cash on hand and equity to not only acquire Blackhawk but pay off all $80 million of its legacy debt at closing. Because of that, it remains virtually debt-free. 

Cash flow reigns supreme

Aside from using equity to finance acquisitions, another reason why these companies have minimal debt is that both focus on generating free cash flow and using that to fund capex and shareholders returns. That said, Frank's International has struggled to produce cash during the oil market downturn, and operated in the red during the first quarter of this year, resulting in it consuming $35.6 million in cash after accounting for capex and cash returns to shareholders. While the company expects to go back to "sustained profitability and cash flow in the eventual market recovery" it's not quite there just yet.

Contrast that with Core Labs, which generated an impressive $23 million in free cash flow last quarter. That's a continuation of its recent strength where the company produced $121 million in free cash flow last year, converting a peer-leading 20% of every dollar in revenue into free cash. It's money the company used to maintain a healthy balance sheet, buy back stock, and pay dividends.

One reason Core Labs generates so much cash is that it operates an asset-light business model since it's more of an oil-field tech company than a service provider. That technology-focused approach enables it to earn industry-leading returns on invested capital and generate steady free cash flow. In fact, the company remained profitable and stayed cash flow positive during the entire oil market downturn, while Frank's International ebbed and flowed between profits and losses in recent quarters.

Comparing the outlooks

Another significant difference between Core Labs and Frank's International is their expectations for this year. Core Labs has steadily proclaimed that its financial results would enjoy a "V-Shaped" recovery once the oil market began to turn. It's a recovery that appears to have taken hold in last year's fourth quarter and will continue in 2017 according to the company. Driving that view is the recent start-up of several long-term major projects, which should drive revenue higher in each quarter of this year and further expand margins.

Frank's International, on the other hand, has a more moderate view of its business prospects because it operates in highly competitive segments of the market. Because of that, its margins are very tight right now, with the company's adjusted EBITDA margin just 1.4% last quarter while Core's margins were in the mid-teens. Further, while CEO Douglas Stephens noted on the company's recent quarterly conference call that it "should deliver improved results in the second half of 2017" the company doesn't expect to generate enough positive free cash flow to cover its dividend this year. Meanwhile, if market conditions head lower along with oil prices, it might continue to operate in the red. 

Investor takeaway

While Frank's International is a cash-rich company that should thrive when market conditions improve, it's not in Core Lab's league when it comes to margins, cash flow generating ability, and clearly visible growth on the horizon. Because of that, Core Labs is the better buy for investors who want an oilfield service stock to ride the upcoming wave of an eventual oil market recovery.