Source: Core Labs.
Oil prices are highly cyclical, and when they crash Wall Street invariably loses its mind and sells off great oil stocks along with the bad. Take, for example, Core Laboratories (CLB), which, while not nearly as badly punished as some energy stocks, is still down sharply since the crude crash began in mid-2014.
CLB Total Return Price data by YCharts
Personally, I think Wall Street is dead wrong about Core Labs. Here's why this particular oil services stock is set to deliver potentially market-crushing total returns over the next decade, no matter when oil prices recover.
Unique, cash-rich business model
"Core converted over $0.24 of every 2015 revenue dollar into free cash flow, again leading all oilfield service companies," said President and CEO David Demshur. "Also in the fourth quarter of 2015, Core once again produced oil industry leading return on invested capital for the 26th consecutive quarter, topping an ROIC of 40%."
Core Labs is the ultimate wide-moat business thanks to its 80-year of expertise that has allowed it to create the best expertise and global database of oil-field characteristics in the industry. To oil companies, knowing where to drill, how to drill, and how to optimize production in the most cost effective manner is worth its weight in black gold.
This, combined with Core Labs' low costs, allows the company to generate staggering amounts of free cash flow. In fact, as the quote from Core's CEO from the company's latest conference call illustrates, Core had a 24% free cash flow margin last year and is one of the most profitable oil service companies in the world.
What's more important for investors, however, is that Core Labs' services are so vital to oil and gas firms that its actual business is far less variable than the industry at large.
Relatively stable and consistent growth
"For the full year, revenues were $798 million, so down 27% but on a constant currency basis down only 23%," said Chief Accounting Officer Chris Hill. "A nice outcome considering the global rig count was down almost 35% over the same period."
CLB Revenue (Annual) data by YCharts
No oil stock is completely immune from the volatility and cyclicality of energy prices. However, Core Labs' revenue, earnings per share, and free cash flow-per-share growth have an astounding record of consistency.
In fact, over the past two decades the company has managed to grow sales, earnings per share, and free cash flow per share at a compound annual growth rates of 10.3%, 14.8%, and 27.8%, respectively.
This has rewarded long-term investors with an annual total returns rate of 20% over the past 20 years, even after accounting for the past two years' price decline. That's compared with the S&P 500's total returns (which include dividend reinvestment) of 8.2%.
What is Core Labs' secret to such mind-blowing returns? And more importantly, can investors expect such outperformance to continue in the years ahead? While I can't promise such returns will continue, there is one secret weapon Core Labs has that's likely to help the stock keep beating the market over the next five to 10 years.
Strong history of returning cash to shareholders
"For the full year, we used our free cash flow and borrowings under our credit facility to pay $94.2 million in dividends and $159.7 million in share repurchases," Hill said.
CLB Stock Buyback (Annual) data by YCharts
Over the past 12 years, Core Labs has put its river of free cash flow to good use by reducing its share count by an impressive rate of 3.5% annually. This strategy increases free cash flow per share and is what has allowed it to not only keep growing its dividend strongly since 2008, but also preserve its payout at a time when so many other energy stocks are slashing theirs.
However, dividend growth investors always need to consider how safe a payout is going forward. After all, since Core Labs took on $75 million in net debt in 2015, the dividend may be at risk if the company's free cash flow payout ratio or leverage ratio is unsustainable.
Fortunately with a Q4 2015 and trailing-12-month cash flow payout ratio of 53%, and 49%, respectively, Core is likely to able to preserve its dividend even should oil prices fail to recover this year.
In addition, the company's interest coverage ratio of 13 means that it should have no trouble servicing its debts with operating cash flows. Management has also wisely chosen to maintain rather than grow the dividend until oil prices recover, as well as divert more free cash flow toward paying down debt.
However, this temporary halt to payout growth shouldn't deter dividend growth investors from investing in Core Labs. That's because its free cash flow rich business model is likely to make strong dividend growth possible once the global glut in oil supplies is eliminated and oil and gas producers are forced to replace falling production.
Bottom line
Core Labs, with its long-term-focused, shareholder-friendly management; unique, wide-moat free cash flow-minting business model; and strong balance sheet, is one of the best situated energy stocks you can own to profit from an inevitable recovery in oil prices.
