It's pretty easy for investors to get distracted by the constant barrage of news about oil prices and up-to-the-minute data on where the market is headed. In fact, though, much of that stuff is all noise that's not worth paying attention to.
One thing that is worth your attention, though, is Core Laboratories' (NYSE:CLB) quarterly conference call. The insights management has about the industry as a whole are a great source for investors looking to get a better feel for the market. Here are five of the big themes discussed on Core's recent conference call that every energy investor should know, in terms of the company and the industry in general.
The U.S. isn't the only one looking to cut
Many investors have been keeping a close eye on indicators such as U.S. production and inventory levels to see when the market might turn back up. But according to CEO David Demshur, there are some indications that the U.S. isn't the only place where we could see signs of a turnaround:
"Internationally, last quarter, Core believed that the ultrahigh levels of Middle East production were not sustainable, and production cuts were announced within weeks of our last quarterly EPS release. Core believes the Middle East production levels will continue to fall in Q4, led by declines in Iraq, notwithstanding unknown and unpredictable crude oil supplies from Iran."
This is probably the biggest reason to listen to Core Labs' quarterly conference call. As a company with clients ranging from mom-and-pop operations to the world's largest oil companies, management has a pretty good pulse on what's going on out there. In fact, some of the very issues Demshur mentioned during the call are starting to take hold.
We're a valueless company?
If you've looked at Core Labs' balance sheet lately, something may seem off: It has a negative equity value. That isn't a mistake. According to Christopher Scott Hill, Core's chief accounting officer, it's actually by design:
Shareholders' equity ended the quarter at a deficit of $5.9 million, down from the year-end balance of $94 million, primarily due to share repurchases and dividends in excess of net income since the end of last year. As we have previously discussed, clearly, book 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 the negative book equity because they return that free cash flow to their owners, just as we have done. We do not have any debt or contract compliance requirements to report positive net worth.
This may sound counterintuitive, but Core has generated free cash flow at a faster rate than net income and has used much of that cash to repurchase shares. Based on GAAP reporting methods for balance sheets, this means it technically has negative equity value similar to a company that's generated more losses than gains. Now we all know that Core Labs' equity is worthless, but that makes it somewhat harder to use valuation metrics such as price-to-tangible book value and return on equity.
The turn hasn't happened yet
One question that so many want answered is whether we're at the bottom of this industry cycle. Prices are likely to be a big part of that, but for many companies it's all about the spending levels of producers. According to CFO Richard Bergmark, it's highly unlikely we'll see that happen this quarter:
Oil company 2015 operating budgets are at very low levels and nearing exhaustion, which we believe will force the North America rig count to further contract later in the fourth quarter. Moreover, extended operating suspensions are likely during the North America holiday season. International rig counts are projected to be flat to down in the fourth quarter as well.
Core's management are not the only ones that seem to think this way, either. Schlumberger (NYSE:SLB) CEO Paal Kibsgaard echoed some very similar sentiments during its recent conference call as well. According to Kibsgaard, the financial pressure on many of Sclumberger's clients has exhausted cash flows, and it will take a bit of a recovery in oil prices to replenish cash before it expects to see any pickup in activity.
Shale drilling still hasn't been optimized
Many U.S. operators have become quite adept at the whole hydraulic-fracturing thing. In a matter of less than a decade, companies have taken shale oil drilling from a fringe technique that would need absurd prices to be economical to a major production source that has proved to be one of the most economical sources of all. Clearly, a lot of progress has been made, but Demshur thinks we still have a long way to go before we have completely optimized shale drilling:
Right now ... we know that we can push a hydrocarbon, a long-chain hydrocarbon, about 120 feet in an average tight-oil reservoir. So if that is indeed the case, we should have a stage every 240 feet or so feet apart. Stages are still more than, on average, 400 feet apart. So we still have some optimization going on the drilling and completion stimulation techniques. We are still proponents of longer laterals. And if you look at companies that are drilling the longest laterals out there, Pioneer Natural Resources (NYSE:PXD) comes to mind, they're 10,000-footers; by looking at the number of stages they're putting in there and the amount of profit, that's still a blueprint for success and higher EURs [estimated ultimate recoveries].
Pioneer Natrual Resources is a great example here. By moving from a 5,000- to a 10,000-foot lateral that Demshur mentioned, Pioneer has improved its net present value for a well by a specacular 247%:
The business takes a jolt
So as companies realize they're better at the fracking process, some are starting to realize that there's an immense opportunity to go back to some of its first fracked wells and get much more out of them. This is turning into a new opportunity for Core Labs, which management is keen to capitalize on while the market for new well work isn't as robust. Chief Operating Officer Monty L. Davis had this to say:
Operators' interest in restimulation of existing wells continues to increase dramatically. Many operators are now looking at refracks as the best solution in meeting their production goals with the least capital dollars. Core has realized the significance of these developments and has dedicated to providing the technical -- critical technical expertise for successful refrack programs. The Production Enhancement team is being utilized to extensively help design, implement, and evaluate potential wells in areas for restimulation. Core is now utilizing both the proppant and fluid diagnostics and working with many operators to help define effective refrack geometry and evaluate diversion effectiveness. This may continue to be a major source of diagnostic work over the next six to 12 months.
So overall, the market for new development and production will probably remain weak for some time, but Core is finding ways to eke out some opportunities to keep cash coming in the door. As long as the company continues to produce technology solutions that improve well economics, producers will line up for Core's services.
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