If you only have time to look through a couple of management conference call transcripts, then one of them should most definitely be Core Laboratories' (NYSE:CLB). With a wide range of clients in terms of geography, size, and types of oil production, Core's management really has its finger on the pulse of the oil market. While its calls do give some very interesting insights into the market, it also is a reaffirmation that Core is one of the best oil services companies out there.
Here are five quotes from management's most recent conference call that reflect its insights into the oil market, why it continues to beat expectations despite the weak oil market, and helps clarify some of the questions that some investors may have when looking at Core's financial statements.
1) The end of oil's decline could strike sooner than some expect
Not many oil executives have been too optimistic about the near-term future for the oil industry. Cheap commodity prices, fears of weakening demand from China, and the possibility of new production from places like Iran has many executives wary of what oil prices will look like the near future. That isn't really the case with Core's CEO David Demshur, though. He sees some better times around the corner:
[B]y year-end, Core sees crude oil markets in balance owing to production declines led by the falls in the U.S. production, stagnating to falling international production, while demand increases due to lower commodity prices take hold.
One thing that gives Core's team some confidence in its outlook is that the company probably knows the decline rate of global oil and gas properties around the world better than almost everyone else. After all, it's Core's job to slow the decline curve. At current drilling activity levels around the world, Core estimates that U.S., Canadian, and Mexican oil production will decline through the second half of the year and international production will flatten. If demand grows as much as the International Energy Agency estimates -- about 1.3 million barrels per day -- then the global supply glut could clear pretty quick.
2) Maintaining strong margins in a rough climate
One of the largest threats to oil services companies as of late has been the pressure put on them by oil producers to lower prices to accommodate the lower oil price environment. Some investors and analysts might have been afraid that this was starting to happen to Core based on a slight margin compression in the previous quarter. According to Chief Accounting Officer Christopher Hill, this wasn't necessarily the case:
Our service operating margins continue to be strong, which confirms pricing did not play a part in our lower margin. Rather, it was the absorption of our fixed cost structure on lower revenue when compared to the prior year.
There have been some slight revenue declines in the past two quarters, but that has been more a result of declining activity than lowered prices. Core has been working to cut some of its fixed costs to maintain margins as well. This indicates that if activity were to increase, Core could benefit more than others since it has been able to preserve its pricing power.
3) Keeping the cash generating train rolling
Core has been very effective at maintaining pricing power to keep margins strong, but what it is even more effective at is turning those operational profits into free cash flow. So effective, in fact, that the company's cash flow has outpaced its net income earnings, Hill said:
[A]fter paying our $5.4 million in CapEx, our free cash flow is $41.3 million for the quarter, which is in excess of our net income. For the first half of the year, we converted over 27% of our revenues into free cash, which generated $114 million in free cash flow and represents 173% of net income.
Core is able to do this because, unlike other companies in all aspects of the oil and gas industry, it is not a capital-intense business. In several instances, its depreciation and amortization expenses are greater than its capital spending. Also, the company doesn't require high levels of working capital to be employed at any time. This has allowed to not only generate cash at a higher rate than net income, but it has also helps to give the best return on invested capital metrics -- by a long shot -- in the oil services business.
4) A zero-equity company?
Yeah, Core Labs has a very weird balance sheet. Even though the company has a market capitalization of $4.5 billion, it only has book value equity of $7 million -- and no, that's not a typo. In fact, the people running Core's books think that the company's book value could be negative in the coming quarters. How is this possible? Accounting Officer Christopher Hill explains:
Depending on our share buyback activity in the coming quarter, we may actually see booked equity go to 0, below 0. Clearly, booked equity does not represent the solvency of a company, and we note that several S&P 500 companies who generate significant levels of free cash also have negative booked equity because they return that free cash to their owners just as we have done.
To understand how this is possible, you need to know some of the nuances of a balance sheet. When a company repurchases shares, those are booked as treasury stock and take away from total equity value. If treasury stock increases faster than retained earnings, then book value equity in the company actually decreases. This happens quite often with Core since its free cash flow typically exceeds earnings. So, in the case of Core Labs, having zero book value isn't a bad thing -- just don't try to evaluate the company on return on equity or price to book value metrics.
5) Shifting capital benefiting Core Labs
Cutting capital expenditures has been a pretty common theme in the oil and gas space as companies look to pocket what little operational cash they generate today. One thing that isn't as discussed, though, is the shift in how those capital expenditures are being used. According to Demshur, companies are looking to spend their capital budgets in a way that will pay off in a shorter time horizon, and that is great for Core Labs:
[A]s opposed to looking at CapEx for drilling exploratory wells, CapEx is now being focused on development. And so we're seeing a lot of the CapEx dollars that were going for exploration, which, as you know for Core, really is not of a high interest to us, going right into our wheelhouse in the development of these discoveries that have been made over the last 3 to 5 years.
In places like the Gulf of Mexico and East Africa, the past half decade has seen dozens of new deepwater well discoveries. As producers start to turn those exploratory wells into producing assets, Core will have plenty of work on its hands to keep it busy for quite some time.
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